Educational Post
A bond is a debt security, similar to an IOU. When you purchase a bond, you are essentially lending money to the issuer, which could be a government, municipality, or corporation. In return for your loan, the issuer agrees to pay you interest (referred to as the coupon) at regular intervals and to return the principal amount (face value) when the bond matures.
Types of bonds
1. Government bonds: Issued by national governments. Examples include US Treasury bonds, UK Gilts, and German Bunds.
2. Municipal bonds: Issued by local governments or municipalities to fund public projects like schools and highways.
3. Corporate bonds: Issued by companies to raise capital for expansion, operations, or other business activities.
4. Savings bonds: Typically low-denomination bonds issued by governments for small investors.
How Do Bonds Work?
Issuance and pricing
When bonds are issued, they have a face value, a coupon rate, and a maturity date. The face value is the amount the bond will be worth at maturity, and the coupon rate is the interest rate the issuer will pay the bondholder. Bonds are sold in the primary market when they are first issued and then traded in the secondary market.
The primary market is where investors purchase bonds directly from the issuer, such as a government or corporation. After the initial sale, bonds can be traded among investors in the secondary market, where prices fluctuate based on factors like interest rates, economic conditions, and the issuer's creditworthiness. The secondary market provides liquidity, enabling investors to buy and sell bonds before they mature.
Interest payments
Bondholders receive interest payments at regular intervals, typically semi-annually or annually. These payments are a fixed percentage of the bond's face value. For example, a bond with a face value of $1,000 and a coupon rate of 5% will pay $50 per year. An example of this is a US Treasury bond with a 10-year maturity and a coupon rate of 2%, which would pay $20 annually on a $1,000 bond.
Maturity
The maturity date is when the bond issuer must repay the bond's face value to the bondholder. Bonds can have short-term maturities (less than 3 years), medium-term maturities (3-10 years), or long-term maturities (more than 10 years).
For instance, a short-term corporate bond issued by Apple might mature in 2 years, while a medium-term municipal bond from the city of Los Angeles could have a 7-year maturity. Long-term bonds, such as a 30-year US Treasury bond, mature after three decades.
