What's a bond?

Understanding all sides of this fixed-income investment.?

Without loans, most of us wouldn’t be able to afford big-ticket purchases like a car, a home, or an education. Similarly, governments and businesses sometimes need loans?to fund new projects or pay for operating costs .?

However, while we can go to a bank and apply for a mortgage, it isn’t that simple for a corporation or the government. These entities usually need?more money than a bank can offer ?them. So, in order to raise the necessary funds, corporations and governments will issue bonds to investors – yes, you can lend the government money.

There are many different types of bonds, so it can be a challenge to figure out their risk levels and earning potential — and the jargon used to describe them can sound like another language sometimes.

Not to worry, Flahmingo is here to help. In this blog, we’ll cover what a bond is, how they can make you money, and how to assess their risk level. Let’s get into it!

So, what is it?

A bond is basically a?formalized I.O.U . — it’s a loan given to a company or government (called the bond issuer) by the investor who purchases the bond (called the bondholder).?

Bonds are?issued by companies and governments to pay for expenses . Sometimes,?the expense is so large ?that the company or government needs to borrow money from more than one source, meaning an individual bond is just one piece of a massive loan.

Once the bond is purchased, the bond issuer?agrees to pay interest ?to the bondholder at regular intervals until the bond matures, as well as a fixed amount known as the?face value or par value ?on the bond’s maturity date.?

Fun fact! A bond’s?face value can be different from the price ?an investor pays for the bond, especially if the investor purchases the bond on a secondary market (a.k.a. from another investor instead of the issuer). When you buy a bond directly from an issuer, its price?is usually set at par ?– the amount the issuer has agreed they owe you. However, a bond’s price on the secondary market can go up and down depending on economic conditions, just like any other investment.

The amount of interest a bond pays (called the coupon), how often it’s paid (usually semiannually), how long it’s paid for (called the bond’s?term or maturity ) and its face value (often set at $1,000 ) vary from bond to bond. These characteristics don’t change over the bond’s lifetime, which is why we categorize bonds as a?fixed-income security . Once you invest in a bond, you generally know what you’re going to get – if you hold onto it until maturity, that is.

There are also zero coupon bonds that are?sold at deep discounts to their face value . As the name suggests, they don't pay regular interest payments but you do receive the full face value once it matures, resulting in a profit.?

Many bonds (depending on the type) are lower-risk investments ?than stocks and other equity investments because they carry the promise of paying you back, which makes them a useful tool in an investment portfolio.

Holding bonds has two major benefits: they give you a stream of income and they offset the volatility of stocks and other investments in your portfolio.

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