Bonds

A bond is basically a loan taken out by a large organization from individual investors.  The organization borrowing money could be the federal or local government, or a business.  A specific amount of money is borrowed, called the face amount, and a higher amount is paid back once the bond matures.  This is usually done in the form of bi-yearly interest installments, with the face value of the bond paid at the end of the term in one lump sum.  If the bond is held past the maturity date, the company is under no obligation to pay additional interest.  This is because bonds are not a stake in the ownership of a company, they are merely a loan.  In general, bonds are not considered as risky as stocks since they will be repaid unless the company defaults.  In most markets, bonds are paid off even if the company is unable to pay stockholders.  The nickname “fixed interest” loan has been credited to the bond because of this reliable nature.

Bonds are mainly sold in the primary, OTC market.  Here, companies and governments sell their bonds directly to investors.  Because bonds are somewhat liquid, they are often resold through secondary markets, or, as they are more commonly referred to, exchanges.  Demand is contingent upon the overall status of the market.  As an additional note: like stocks, bonds can be bought as part of an index.  There are many indices out there that carry popular bond baskets.  They can also be sold as futures or options, if one so desires.

Before I go any further, I must make note that bond values do not simply stay put.  True, once you buy a bond, you are locked in to the specific terms of that bond.  But what makes bonds attractive to investors is their respective yield.  This indicates the difference in interest rates paid from issuance to issuance of each set of bonds.  When the overall market is in a bear phase, bond interest rates will generally go up in order to attract more investors.  While this makes bonds less risky than stocks, there is no guarantee that the market will not continue to fall, thus giving birth to even higher rates.  This is known as interest rate risk.  This is also where the volatility of the bond market comes into play.  Oftentimes, traders will buy and sell bonds prior to their maturation.  This, if done improperly, can be dangerous since yields are always in flux.  It is much safer to buy a bond and wait the ten years or so until it matures, collecting a steady source of income.  There is no doubt, however, that bonds can be a steady source of supplementary income to the smart investor’s portfolio. 

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