Bonds (And How They Work)
A bond is a financial instrument used by governments, corporations, and other organizations to raise capital.
It represents a debt obligation, meaning that the issuer (borrower) promises to pay the bondholder (lender) a specified amount of interest over a fixed period of time and to return the principal amount at the end of the bond’s term.
Bonds are typically issued with a face value, which is the amount that the bondholder will receive at maturity, and a coupon rate, which is the interest rate that the issuer will pay periodically throughout the life of the bond.
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Bond Rates, Markets, And Risks
The coupon rate is typically fixed, but in some cases, it may be variable, based on a benchmark interest rate like the LIBOR.
Bonds are typically sold to investors through a bond market, either directly by the issuer or through intermediaries such as investment banks or brokerages.
The market value of a bond can fluctuate based on changes in interest rates, inflation, and other economic factors.
When interest rates rise, the value of existing bonds decreases, since investors can earn higher returns by buying newly issued bonds with higher coupon rates.
Bonds are considered less risky than stocks, since they offer a fixed income stream and have a defined maturity date.
However, they are still subject to credit risk, which is the risk that the issuer may default on its obligations and be unable to make payments to bondholders.
Bondholders also face reinvestment risk, which is the risk that interest rates will fall, causing the issuer to call the bond early and forcing the investor to reinvest at a lower rate.
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