Bonds
An Introduction

You've probably heard of bonds, as in the phrase "stocks and bonds" or "buy war bonds." What exactly is a bond? A bond is a way for a company to get capital for investments, or for a government to get funds if taxes aren't enough. When someone buys a bond, they are effectively lending money to a corporation, knowing that it will be paid back at a specified point in the future, with interest.

The price a bond is sold for is called the par value of the bond. Bonds have a fixed interest rate set at the time that a bond is bought. They are called fixed income securities. (A security is something like a bond or a stock certificate that proves that you own something). Bonds are less risky than stocks, because the price of a stock fluctuates, but the price of a bond does not. When you buy bonds you are assured of income over a period of time, with your original invest paid back at the end.

Why would a company issue bonds? If a company issued more stocks to make money, it would lessen the value of the stocks already available because each would represent a smaller share of the company. This would upset shareholders, so a company may issue bonds instead. Governments must issue bonds, because a government cannot issue stocks.

The amount of time between when a bond is issued and when it is payed back is called the term of the bond. Short-term bonds have a term of under a year, while long-term bonds have a term of 30 years or more. Bonds with terms falling between these two extremes are called intermediate-term bonds. Bonds that have a longer term tie up your money for a longer period of time, so they usually have higher interest rates to compensate you for this risk. If you plot a graph of the interest rate of a bond versus the term of the bond, you get what is called the yield curve.

Bonds with the same terms tend to have the same interest rates, because companies must compete for investors. If you can invest in Company A which pays 12% interest and Company B which pays 10% interest, chances are you'll pick Company A. Thus, most companies tend to pay the same interest rates.

While bonds are safe investments, they generally do not make you as much money as stocks, so some people trade bonds. If you own a bond that pays 10% interest, and the current interest rate is 8%, people will be eager to obtain your more valuable bond. Bond trading can potentially net you more money than holding on to the bond.