There may have been more than one occasion when you might have had to borrow money from a friend: at the coffee shop, in the office, or even for the cab service. When you run out of money, borrowing is usually your only way out. Juxtaposing the same with big corporations and the federal government, one would find it is not that easy for them. Not only have they to repay the money owed, but to top that amount with interest. That is why companies are made to sign a bond by law, promising the repayment of the money owed. It is a formal kind of security to ensure due payment.
However, certain criteria ought to be considered before investing in a bond. Let us take a short tour through how investing in a bond could benefit you.
Before Investing
The working of a bond primarily depends on whether you need to invest money for a long or short term. Besides, it also depends on your tax status, the period and investment goals. There are some basic strategies on hand, which should be considered before making any investments. For instance, putting all your assets and risks in one single asset class would not be a good idea. It is better to diversify the risks by creating a portfolio of several bonds within the bond. By choosing different issuer's bonds, you could protect yourself from the possibility that one of the issuer's may not be able to pay back the amount owed.
After Investing
After investing, a par value, or the amount of money the investor receives after maturity of the bond, is calculated. This means the amount (principal) owed should be returned to the investor. The coupon rate is the amount received by the bondholder as the percentage of the par value. Lastly, a maturity date is arrived at wherein the bond issuer needs to return the principal amount to the lender.
To arrive at how much a bond would yield, one could divide the amount of interest paid over the course of a year by the current price of the bond. Prices of bonds fluctuate; hence, the current price is always taken into consideration. However, if you decide to sell before the maturity date, it is advisable to do it at the current rate of the market.
Types of bonds
There are different types of bonds available. For example, government, corporate, agency, mortgage-backed securities, municipal, etc. In addition, different maturity level bonds are also available; these help in managing the interest rate risk.
The treasury bonds available from the US government have maturity dates ranging from 3 to 5 months to thirty years.
Corporate bonds, on the other hand, which are sold through public security markets, are a little risky and have high interest rates.
Local and state government bonds have higher interest rates, as unlike the federal government, there are more chances of them going bankrupt.
Foreign bonds are difficult to buy, and is mostly done as a part of a mutual fund. However, investing in them can turn out to be risky.
To conclude, even though certain bonds may be risky, or offer a lower rate of interest, buying bonds are a safe option, as they are sound investments. Securing a number of bonds gives the owner a good credit rating and helps to prove his or her financial stability.
Friday, September 19, 2008
Introduction to Bonds
If you are relatively new to investing, you probably have heard of stocks, but know absolutely nothing about bonds. They do not offer the same sex appeal as stocks. Movies such as Wall Street and Boiler Room have gotten many neophyte investors excited about the stock market, and not once are bonds even mentioned in these films. Bonds are somewhat perplexing; the terminology is a little confusing. This article will hopefully help you understand how bonds work and whether or not they sound like an appropriate investment vehicle for you.
Simply put, corporations, governments, and municipalities borrow money by issuing bonds for sale to the general public. Companies sometimes need additional monies to expand their business, while governments need money for infrastructure. And just like any other loan, the bondholders are paid an interest rate on their money. And, generally speaking, at the end of a certain term, the borrower has to pay back the face amount of that loan.
Interest payments are made at a predetermined rate and schedule. The interest rate is usually referred to as a coupon. The date on which the borrower has to pay back the principal is known as the maturity date. If the lender holds the bond until maturity, he or she will get their principal back. So, for example, if you lend a company $10,000 by purchasing a corporate bond, and it pays an 8% coupon and has a maturity date of 10 years from now, that means you will be paid $800 per year for the next 10 years, and then you will get back the entire initial investment on the maturity date.
Bonds are considered debt instruments, whereas stocks are equity. The reason why stocks represent equity, or ownership, in a corporation, is because stockholders are entitled to receive a portion of the earnings in a corporation, whereas bondholders are only entitled to receive interest payments on their loan. If the bond issuer goes bankrupt, bondholders have a higher claim on the assets derived from the liquidation of the company; stockholders are compensated only after everyone else if a company goes belly up, and sometimes get nothing at all.
There are basically 3 different types of bonds. Government bonds are issued by the federal government, and are considered the safest as is the debt of any country with economic stability. Municipal bonds are issued by local governments, and are also considered safe. More importantly, municipals are exempted from federal tax and often from state taxes as well, making them a very lucrative investment. Finally, there are corporate bonds, which can be risky, depending on the financial condition of the company that is doing the issue.
I hope this information has helped you become familiar with bonds. Try to set aside some money for investing and start while you are still young. The earlier you begin, the more money you can potentially make down the road. Carefully research the credit rating of the company when investing in corporate bonds, and go for municipals or government issues if looking for security.
Simply put, corporations, governments, and municipalities borrow money by issuing bonds for sale to the general public. Companies sometimes need additional monies to expand their business, while governments need money for infrastructure. And just like any other loan, the bondholders are paid an interest rate on their money. And, generally speaking, at the end of a certain term, the borrower has to pay back the face amount of that loan.
Interest payments are made at a predetermined rate and schedule. The interest rate is usually referred to as a coupon. The date on which the borrower has to pay back the principal is known as the maturity date. If the lender holds the bond until maturity, he or she will get their principal back. So, for example, if you lend a company $10,000 by purchasing a corporate bond, and it pays an 8% coupon and has a maturity date of 10 years from now, that means you will be paid $800 per year for the next 10 years, and then you will get back the entire initial investment on the maturity date.
Bonds are considered debt instruments, whereas stocks are equity. The reason why stocks represent equity, or ownership, in a corporation, is because stockholders are entitled to receive a portion of the earnings in a corporation, whereas bondholders are only entitled to receive interest payments on their loan. If the bond issuer goes bankrupt, bondholders have a higher claim on the assets derived from the liquidation of the company; stockholders are compensated only after everyone else if a company goes belly up, and sometimes get nothing at all.
There are basically 3 different types of bonds. Government bonds are issued by the federal government, and are considered the safest as is the debt of any country with economic stability. Municipal bonds are issued by local governments, and are also considered safe. More importantly, municipals are exempted from federal tax and often from state taxes as well, making them a very lucrative investment. Finally, there are corporate bonds, which can be risky, depending on the financial condition of the company that is doing the issue.
I hope this information has helped you become familiar with bonds. Try to set aside some money for investing and start while you are still young. The earlier you begin, the more money you can potentially make down the road. Carefully research the credit rating of the company when investing in corporate bonds, and go for municipals or government issues if looking for security.
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