A bond is a debt security issued by either a corporation or a government entity. Bonds are considered fixed-income instruments because they provide investors with regular interest payments, typically semiannually, and return the principal amount at the bond’s maturity date. Bonds represent a loan made by investors to the bond issuer, which can be a corporation (corporate bonds) or a government entity (government bonds or municipal bonds). Here are key points about bonds:
- Fixed-Income Security: Bonds are called fixed-income securities because they offer a fixed, predetermined interest rate, also known as the coupon rate. This interest is paid to bondholders at regular intervals.
- Issuer: Bonds can be issued by various entities, including corporations, municipalities (municipal bonds), states (state bonds), and sovereign governments (government bonds). Each type of issuer has distinct characteristics and risk profiles.
- Investor as Creditor: When an individual or institution purchases a bond, they become a creditor or debtholder of the issuer. The issuer is legally obligated to pay the bond’s interest and return the principal amount to bondholders at maturity.
- Coupon Payment: The interest payment made to bondholders is known as the coupon payment. It is calculated based on the bond’s face value (par value) and the coupon rate. For example, a bond with a face value of $1,000 and a 5% coupon rate pays $50 in annual interest ($1,000 x 5%).
- Maturity Date: Bonds have a fixed maturity date when the issuer repays the bond’s face value to bondholders. Maturity dates can range from a few months to several decades, depending on the type of bond.
- Market Price: Bond prices can fluctuate in the secondary market due to changes in interest rates, creditworthiness of the issuer, and market conditions. These price changes can impact the yield that investors receive if they buy or sell bonds before maturity.
- Credit Ratings: Credit rating agencies assess the creditworthiness of bond issuers and assign credit ratings to bonds. These ratings help investors evaluate the risk associated with a particular bond.
- Use of Proceeds: Bonds are used by issuers to raise capital for various purposes, including financing infrastructure projects, funding business operations, or supporting government activities.
- Diversification: Bonds provide investors with diversification opportunities in their investment portfolios, balancing risk when combined with other asset classes like stocks.
Bonds are a fundamental component of the financial markets, offering a range of investment options with different risk-return profiles. They are often considered a lower-risk investment compared to stocks and can provide income, capital preservation, and portfolio diversification benefits to investors.