Overview
A bond is a debt instrument issued by an
investor to a governmental or corporate entity to finance its activities
and projects. Bonds are commonly referred to as fixed income earning
securities. A bond is similar to an IOU given by a borrower (the issuer)
to a lender (the investor).
How It Works
A corporate organization may require funds to construct new
buildings. A municipal corporation may need to raise capital to
construct a new hospital. These types of projects need to be backed by a
huge sum of money. Issuing a bond is an economical way to arrange for
such capital. The entity will issue a bond to the lender and agree to
redeem the borrowed money with the stated interest when the bond
matures. The issuer is in the position of a borrower of the loan. The
return on that loan is the promise to repay the original principal with
the interest when the bond matures.
While choosing a bond, the following factors need to be considered
seriously: the bond's maturity, redemption features, credit ratings,
interest rate, price, return, and tax status. There are different types
of bonds including U.S. government securities, municipal bonds,
corporate bonds, mortgage and asset backed securities, federal agency
securities and foreign government bonds.
Benefits
The diversity of these fixed income earning securities gives
prospective investors an opportunity to customize investments in
accordance with their financial objectives. Bonds ensure investment
stability in times of volatile markets. They give steady and predictable
payments and sometimes even tax-free income. Bonds offer high rate of
return and are an extremely attractive investment alternative.
Cost/Pricing
The price paid for a bond is based on a variety of variables
including interest rates, supply and demand, credit quality, maturity,
and tax status. Newly issued bonds buy and largely sell at or close to
their face value. On the other hand, the price of bonds in the secondary
market fluctuates in response to changing interest rates. When the
price of a bond increases above its face value, it is said to be selling
at a premium. When a bond sells below face value, it is said to be
selling at a discount. The price of bonds are quoted as a percentage of
the face (or par) value in newspapers and other publications. The
expected rate of return may vary when an investor buys or sells an
existing bond as he pays different prices at different points of time.
Timing
An investor can invest in bonds at every stage of his life. There are
no hard and fast rules about when you should invest in bonds because an
individual's investment strategy will change over time.
Companies/Industries
Most investors are likely to work with financial professionals for
investing in bonds. These consultants are given different titles:
financial advisors, brokers, sales representatives, stockbrokers,
account executives, or registered representatives. They assume complete
responsibility of managing the investor's personal wealth building
strategy.
