Bond Definition and Concepts
Bonds are issued by a corporation, government or any of its agencies to cover any money the purchaser of the bond has lent to the entity. Bondholders are classified as creditors, whereas stockholders are referred to as company owners.
Many financial experts recommend the inclusion of bonds in investment portfolios. They play an important role in every country's economy.
Bonds provide a higher level of security compared to stocks. However, the returns you get on bonds are lower. Thus, bonds are characterized with stability and security.
The combination of stocks and bonds in your investment portfolio is recommended by every financial expert. As for the proportion of each of them, it all depends on the level of risk you are comfortable with. The more risk you are willing and able to take, the more stocks you should include. On the other hand, if you are not comfortable with taking risky investment initiatives include more bonds in your portfolio.
There are several financial entities from which you can purchase bonds:
Most corporations issue bonds if they need money to finance their initiatives or recover their activities. Other purposes include expansions, acquisitions and etc. in order to provide themselves with additional resources, corporations can also issue stocks.
The typical time period for maturity is no more than 40 years. Additionally, corporate bonds are issued in $1,000 denominations.
- Governments and their agencies
If you are looking for extremely secure investment opportunity you should direct your attention to the purchase of US Treasury Bonds. They represent one of the safest bonds since the US government guarantees them. Additionally, US Treasury Bonds have different maturities and denominations.
For the purposes of funding different government programs, various US government agencies issue bonds as well.
- Municipal governments
For the purposes of infrastructure projects financing many municipal governments issue bonds.
In order to gain a greater understanding of the nature of bonds you should become familiar with the following bond concepts:
- Par value
(also known as face or principal value)
Par value represents the amount of money the holder of bonds will receive when the bond matures. For instance, when a bind with a par value of $1,000 reaches maturity it will be again worth $1,000.
This is the time period until the bond holder receives back his/her par value. The maturity period defers greatly from bond to bond. After this predetermined time period expires, the bondholder receives back his/her par value.
The interest rate you will receive from a bond is referred to as a coupon. A book of coupons is sent to the bondholder, which s/he should send to receive his/her interest. The interest rate on bonds is most of the times of a fixed character. Nevertheless, some bonds provide interest rates of varying character.
Yields come in a variety of forms. Some of them are:
It takes into consideration the current market value of the bond. Sometimes the market value may differ from the par value. As a result you can get different returns.
The nominal yield represents the interest rate (that is the coupon you own).
Yield to maturity
Yield to maturity is the most often sited yield the media refers to. It assumes that the interest payments are reinvested at the rate of the bond's coupon. The yield considers:
- The current market price
- The coupon rate
- Time to maturity
When doing a yield calculation, it is recommended to use a computer program or a yield calculator.
- Current yield
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