Thursday, December 23, 2010

Bonds

Bonds are a type of fixed-income investment. Basically bonds are tradeable IOU's. From the borrower's perspective a company can borrow money from a bank in the form of a term loan, or it can borrow money in the capital markets in the form of bonds. Many individual investors will lend a small amount of money to the company, in exchange for coupon (interest) payments based on a fixed rate and eventual return of principal. As part of this the company will issue the investor with a certificate or statement verifying the obligation. If the investor wants to get their money back they can sell the bond to another investor. The other investor will pay the original investor an amount of money and then the new investor will become the one who is entitle to receive the coupon payments and principal at a future date. The price of a bond will change over time as market interest rates change, if interest rates go up the price of a bond will fall - this is because investors will be less willing to pay as much for the relatively lower interest payments (think about it like this; if market interest rates were 10% and a bond had a coupon rate of 5% the only reason to buy that bond would be if the price fell so that the coupon payments would be higher relative to your investment). Thus bonds provide investors with income, as well as the possibility of capital gain or loss. If the bond is held to maturity then there will be no gain or loss, but if the bond is held in a mutual fund the fund will be required to mark-to-market (or value) the bond each day. Bonds are an important security in the capital markets, and account for billions if not trillions of dollars.

Synonyms: Fixed income securities, Debentures, Capital notes, Floating rate notes, Debt securities, Debt capital

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