Money is a necessity people need to live their daily lives, and it is common for people to borrow the money they need for things such as housing. Companies and the government also need money in order to survive day-to-day and to grow their business and interests. Businesses and government often will require larger sums of money than a bank can give to them. As a solution, bonds are issued to the public.
How a Bond Works
The issued bonds allow thousands of investors the ability to provide the company or government entity the capital it needs to expand. Essentially, the investor of the bond is really a lender of money to the company who is referred to as the issuer. The issuer must give the investor something in return for the use of their monies. Interest payments are then returned to the investor. These payments are made at a rate and schedule which is predetermined at the time the bond is issued. The interest rate on the investment is typically known as a coupon. The designated date where the issuer must repay monies borrowed is referred to as the maturity date.
Bonds are called ‘fixed-income’ securities. This term is used because the investor knows exactly how much cash they will receive back if the bond is held until its maturity date. Over a period of time, you will receive interest payments for the set amount of time. When the bond has reached its maturity date, the investor will then get their full amount of investment back.
Bonds are considered a debt. The term bond is often coupled with the term stock. Stocks are not considered a debt, rather they are equity and it is important that investors know the different. As a stock purchaser, the investor will become part owner in a business. This gives the investor the right to vote and share on the profits of the company into the future.
Lesser Risk Benefits
Investors that purchase a bond will not own part of the company but will become a creditor of the company. By purchasing the debt of a company, the investor has more claim rights on company assets than a shareholder would. Investors will not share any profits the company makes however, in the event of a bankruptcy situation, creditors will get paid before shareholders are able to collect.
Bonds are considered to be a less-risky investment strategy than purchasing company stocks. While the return may be lower for bonds, there is less worry about recouping monies invested plus interest.
Bonds are a good option for diversifying investment portfolios when also investing in stocks and other vehicles. Because of their lesser risk, they are a stable way to earn additional investment income while still taking some risks with other investment types like stocks. The returns with bonds will be lower but their predictability makes them easy to work within your overall investment portfolio and investment strategies.
Simon Zhen is a research analyst for MyBankTracker. He is an expert on consumer banking products, bank innovations, and financial technology.
Simon has contributed and/or been quoted in major publications and outlets including Consumer Reports, American Banker, Yahoo Finance, U.S. News – World Report, The Huffington Post, Business Insider, Lifehacker, and AOL.com.