Question: What Are Bonds?
Answer: Bonds are another word for loans taken out by large organizations, such as corporations, cities, and the U.S. Government. Since these entities are so large, they need to borrow the money from more than one person or bank.
Therefore, bonds are a piece of a really big loan. The borrowing organization promises to pay the bond back, and pays interest during the term of the bond. Since large organizations don't like to actually say they are borrowing money, they say they are selling bonds...presumably because it sounds better.
Like loans, bonds return interest payments to the bond holder. In the old days, when people actually held paper bonds, they would redeem the interest payments by clipping coupons. Today, most bonds are held by the financial planning institution, and interest is automatically accrued for the life of the bond.
Bonds are usually resold before they mature, or reach the end of the loan period. This is how bonds rise and fall in value. Since bonds return a fixed interest payment, they tend to look more attractive when the economy and stocks market decline. When the stock market is doing well, investors are less interested in purchasing bonds, and their value drops.
Like stocks, bonds can be packaged into a bond mutual fund. This is a good way for an individual investor to let an experienced mutual fund manager pick the best selection of corporate bonds. A bond fund can also reduce risk through diversification. This way, if one corporation defaults on its bonds, then only a small part of the investment is lost.
Bonds FAQ
- What Are Bonds?
- What Types of Bonds Are There?
- How Do Bonds Interact With the Stock Market?
- How Do Bonds Interact With the U.S. Economy?
- How Do Bonds Affect Mortgage Interest Rates?
