Learning About Bonds

March 23, 2011

Mr. Hamilton’s Business Management
 An IOU?

• A bond is like an IOU for a loan you’ve made to

an institution like the government or a
corporation. Similar to when you take out a
car loan or a mortgage, when the government
or a corporation borrows money from you
they do so for a certain period of time at a
certain rate of interest.
 Basics of a Bond
• When you purchase a bond you are lending
money to the issuer, who can be a
corporation, the government or a government
agency.
 Basics of a Bond (continued)
• In return for the loan the issuer promises to pay you (the
bond investor) a specific rate of interest known as the
“coupon rate”.
• You are paid the interest on a predetermined schedule
(usually quarterly) for the life of the bond. The life of a bond
refers to the period of time the issuer has to repay the
investor. The issuer also promises to repay the face value
when the bond matures (i.e., comes due). The face value
is also known as “the principal” or the “par value.”
Most bonds are issued with a $1000 face value.
 Fixed-Income Investments
• Bonds are also known as fixed-income
investments because the investor knows the
rate of interest and the interest payment
schedule in advance of purchase. Bonds are
often included in a diverse investment
portfolio. There are a variety of bonds
available. Described below are the bonds most
familiar to individual investors:
 Corporate bonds
• Bonds are major sources of corporate
borrowing. Debentures, the most common
type of corporate bond, are backed by the
general credit of the corporation, while asset-
backed bonds are backed by specific corporate
assets, such as property or equipment.
 Municipal and Agency Bonds
• Municipal bonds - Millions of bonds have been issued by
state and local governments. General obligation bonds are
backed by the full faith and credit of the issuer, and
revenue bonds by the income generated by the particular
project being financed.
• Agency bonds - Some government sponsored but
privately owned corporations (like Fannie Mae and
Freddie Mac), and certain federal government agencies
(like Ginnie Mae and Tennessee Valley Authority) issue
bonds to raise funds either to make loan money available
or to pay off new projects.
 U.S. Treasury bonds
• US Treasury bonds are backed by the full faith and
credit of the United State government. When the
government spends more than it collects in taxes
and other revenues, it issues Treasury notes, bills,
and bonds to borrow the money to pay the
difference. Treasury bonds have the longest term or
period of time before the loan must be repaid (10
years or more). Treasury bills have the shortest (less
than two years). © 2009 SIFMA Foundation for
Investor Education. All rights reserved. 2 of 4
 Important to Research Bond Investments
• There are a number of key variables to consider when
purchasing bonds for your portfolio. The bond’s maturity,
redemption features, credit quality, interest (or coupon)
rate, price, yield and tax status help determine the value
of the bond and how well it meets your investment needs.
• Investors want to know the risks in buying a bond. They
can get a bond’s rating information directly from rating
services, financial press, or from a broker or financial
adviser. Standard & Poor's, Moody's Investors Service, Inc.,
and Fitch are a few of the more popular rating services.
 Vocabulary

• Default: Failure to pay principal or interest when due. Defaults can also occur
for failure to meet non-payment obligations, such as reporting requirements,
or when a material problem occurs for the issuer, such as a bankruptcy.

• Fixed-Income Investments: Pay interest on a set schedule. Fixed-Income

Investments include corporate, municipal, agency, and U.S. Treasury bonds.

• High-Yield Bonds: To attract investors, the issuers of these bonds pay a higher
rate of interest than investment grade bonds with the same maturity. They
are rated below investment grade bonds and are also called “Junk Bonds.”
 Vocabulary (continued)
• Issuer: An entity which issues and is obligated to pay
principal and interest on a debt security.
• Interest rate: Compensation paid or to be paid for
the use of money. Interest is generally expressed as a
percentage rate. (Also referred to as coupon rate)
• Investment Grade Bonds: Bonds that are sold by a
very reliable issuer, the government, a large
corporation, or a government agency that is most
likely to repay the loan and the interest as promised.
 Vocabulary (continued)
• IOU: Means exactly as it sounds, “I Owe You.” It is an
acknowledgement of a debt.
• Maturity: The date when the principal amount of a security is payable
• Par value: The principal amount of a bond or note due at maturity.
( also referred to as face value)
• Prepayment: The unscheduled partial or complete payment of the
principal amount outstanding on a mortgage or other debt before it is
due.
• Principal: The face amount of a bond, payable at maturity (also
referred to as face or par value)
• Trade date: The date when the purchase or sale of a bond is
transacted.