Bonds

What are they and What do they do?

Bonds Defined
Bonds are, at their basis, loans given to either a government or

to a corporation. Bonds have three basic components: The Par Value This is the amount that the purchaser pays for the bond, and that will be repaid by the issuer when the bond matures. This can also be referred to as the Principle invested or the Face Value of the investment. The Maturity This is the length of time before the bond is repaid by the issuer. The Coupon Rate This is the interest rate that will be paid by the issuer to the purchaser of the bond. This can be different than the Yield on the bond, which is the annual rate of return on the bond if it were held to maturity.

Rating Bonds
Bonds are rated on their risk be specialty

ratings companies, such as Moodys or Standard and Poors. They are rated AAA (The Highest or Safest) through D (The riskiest)

The higher the rating, generally the lower the coupon rate due to the decreased risk The lower the rating, generally the higher the coupon rate due to the increased risk associated with it

Discount?
Bonds are not always kept until they reach

maturity They usually can be resold at any time due to changes in expected returns or the financial needs of the holder If interest rates have changed since the bond was issued, the holder may have to sell the bond for less than par value to get someone to purchase it

This is referred to as selling at a discount

Issuing Bonds - The Good.

Bonds are beneficial to the issuer for a couple

of reasons: Upon issuance, the coupon rate is guaranteed the financial obligations involved are then known and stable Bond issuance does not impart ownership of the issuing entity to the bond holder

Issuing Bonds The Bad.

Upon issuance of a bond, the issuer is legally

obliged to make the set payments regardless of economic conditions Coupon rates are heavily influenced by the financial health of the issuing entity so economic changes can greatly impact the ability to, and the cost of, issuing bonds

Types of Bonds
Bonds can be loosely grouped into 5

categories: Savings Bonds Corporate Bonds Municipal Bonds Treasury Bonds Junk Bonds

Savings Bonds
Savings Bonds are low par

value bonds issued by the US Government. They do not draw interest payments instead the bond is purchased for less than par value. For example: A $100 par value bond will be purchased for $50. When the bond matures in 20 years, it pays out the $100 to the holder.

Corporate Bonds
Corporate Bonds are high

par value bonds issued by independent corporations. Interest earned on these bonds is taxable by the US Government. They are generally considered of moderate risk because they are only backed by the future success of the corporation. The issuance of corporate bonds is regulated by the Securities and Exchange Commission (SEC)

Municipal Bonds
Municipal Bonds are

issued by State and Local Governments. Interest earned on these bonds is not taxable by the US Government. These are generally considered low risk because they are backed by the tax revenues of the issuing entity.

Treasury Bonds, Bills, and Notes

The US Government

issues bonds of various maturity lengths. These bonds are considered some of the safest investments in the world because they are backed by the full faith and credit of the United States government.

Junk Bonds
Junk Bonds sometimes

offer the highest yields of any bonds. This is because they also offer the highest risks of any bonds. There coupon rates are set very high to entice purchasers to take the risk that they present.