Bonds are investment securities that allow investors to lend money to companies or governments for a specific period of time in return for regular interest payments. The bond issuer will return the investor’s money once the bond has reached maturity. Fixed income is often used to describe bonds because your investment earns fixed payments throughout the life of the bond.
To finance their ongoing operations or new projects, companies sell bonds. The government sells bonds to fund purposes and supplement income from taxes. You are a debtholder when you invest in bonds.
Bonds, particularly investment-grade bonds are less risky than equities and can be a crucial component of a balanced investment portfolio. Bonds can be used to hedge against the volatility of stocks and provide income for your retirement years.
Key Terms for Understanding Bonds
It is important to first understand the key terms that all bonds use before we can examine the various types of bonds and how they are priced in the market.
- Maturity Date on which bond investors return the money borrowed to them. There are three types of maturities for bonds: short, medium, and long.
- Face Value: Also called par, the face value of a bond is how much it will be worth when it matures. The bond’s face price is used to calculate the bondholders’ interest payments. Commonly, bonds have a par amount of $1,000.
- Coupon The fixed interest rate that the bond issuer charges its bondholders. If a $1,000 bond comes with a 3% coupon, it promises to pay $30 per year to investors until the bond matures (3% of $1,000 = $30 per thenum).
- Yield The rate at which the bond returns its principal amount. The coupon is fixed but the yield is variable. It depends on the bond’s secondary market price and other factors. You can express yield in three ways: current yield, yield at maturity, and yield to call. (more details below).
- Price Many bonds, if not all, are traded after being issued. There are two types of prices for bonds: ask and bid. The seller offers the lowest price, while the buyer pays the highest bid price.
- Duration risk This is a measure of how the price of a bond might change with changes in market interest rates. Experts recommend that a bond’s price will drop 1% for every 1% rise in interest rates. The greater the bond’s term, the more exposed it is to interest rate changes.
- Rating: Rating agencies give ratings to bonds and bond-issuers based on creditworthiness. The bond ratings assist investors in understanding the risks associated with investing in bonds. Ratings of investment-grade bonds are BBB or higher.
This post was written by All Seasons Wealth. At All Seasons Wealth, we provide expert advice and emphasize the importance of creating in-house portfolios to personalize your strategy for asset management, financial planning, and cash management. We utilize research and perform market analysis to provide you with a Financial advisor in Tampa. No matter your needs, we can work with you to develop a consulting solution tailored to you.
Any opinions are those of All Seasons Wealth and not necessarily those of RJFS or Raymond James. Investing involves risk and you may incur a profit or loss regardless of the strategy selected. Investing involves risk and you may incur a profit or loss regardless of the strategy selected. Every investor’s situation is unique and you should consider your investment goals, risk tolerance, and time horizon before making any investment. Past performance may not be indicative of future results.