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Bond Basics Part 1: What, Who, and Why?
Tue Nov 19, 2013 02:10 EST
What Are Bonds?
An interest-bearing instrument that promises to pay a stated amount of money at some future date.
Bonds are redeemed at the end of a term, which is called a maturity date. Some bonds have "call dates." Issuers may call bonds earlier than its maturity date if doing so suits them at that time. Other bonds have "put features." This is the opposite of a call date. "Put" allows the holder to sell the bond back to the issuer at a predetermined price before the stated maturity date.
When you buy a bond, you are in effect "lending money" to the issuer, much like an "I.O.U."
Who Issues Bonds and Why are They Issued?
Bonds are issued by many types of entities, including Governments, Corporations, Municipalities, and Federal Agencies.
Bond issuers issue bonds generally to fund their operation. They pay the owner interest so long as the bond is outstanding.
When a bond is issued, the issuer assumes that they can earn more in their business than they are paying out on the interest payments. For a corporation, by example, this means it feels their "return on equity" will exceed their interest payment rate.
Bonds can be issued to fund an acquisition, to fund general corporate purposes, or to pay off a maturing bond issued previously.
Why Invest in Bonds?
Most financial advisers, investment advisers, or stockbrokers recommend that portfolios are properly "balanced," otherwise known as asset allocation.
Bonds are generally more stable than equities and have a predictable stream of income, acting as a "shock absorber" in the overall scope of a portfolio.
Be sure to read the rest of the Bond Basics series: