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Bonds

Overview

A bond is a loan that you make to a government organization (state or national), local municipality or a major corporation (such as Ford, GE, GM, etc). Since these organizations need so much more money than they have, they borrow money from the public through bonds. The benefit to the public is that in exchange for your loan, the entitity that sells you the loan agrees to pay you interest on the loan throughout the term of the loan.

Bond Vocabulary

  • The "term" or "maturity" of the bond is the length of the loan, which can be anywhere from 90 days to 30 years.

  • The "face value" of the bond is the amount of money that you have lent them - the amount that was paid up front to obtain the bond. It is also the value of the bond and the amount that you will receive on the bond's maturity date.

  • The "coupon" on the bond is the interest rate you will be paid each year.

For example, you might buy a bond from the government with a $1000  face value, a 6% coupon and a 10 year maturity. This means that when you buy the bond, you give the government $1000 on the purchase date. Then, each year, for the next 10 years, the government will pay you $60 (the 6% coupon). At then end of the 10 years, on the maturaty date, the government will pay you back the full $1000 that you lent them.

Types of Bonds

There are three types of bonds:

  • US Government:
    • US Treasury Bills - 90 day to 1 year terms
    • US Treasury Notes - 1 year to 10 year terms
    • US Treasury Bonds - 10 year to 30 year terms

US Government bonds are often the most popular because they are the most reliable. While the economy may faulter, chances of the US Government going belly up are pretty slim. Also, the government even offers tax exempt bonds as an incentive for the public to participate in bond programs.

Click here for 7 great reasons to invest in US Government Bonds.

  • Corporate
    • Short Term - 1 to 5 years
    • Intermediate Term - 5 to 15 years
    • Long Term - 15 years or longer

Corporate bonds are a less reliable than US Government bonds simply because you can never know for sure what will happen to a company in the future. There are companies that rate corporate bonds such as Standard and Poors and Mood's Investors Service and this gives you a better idea of the amount of risk you are taking, but they can only rate on past performance and cannot see into the future.

  • Zero Coupon. Zero coupon bonds do not offer an interest payment each year that you hold the bond like the others do. Instead, the bond is worth the face value at maturity, but you buy it at a price less than the face value. These are good for people saving for college or retirement, people who do not need the money every year, and are not relying on the coupon payment each year. Since a payment is not made every year, zero coupon bonds generally offer a slightly higher yield at the end. One downfall to be aware of, however, is that you are still required to pay taxes on the accrued interest throughout the years so you may still have to choke up the tax dollars before you receive full payment on the bond.  


Benefits

The biggest benefit of bond investments over other investment options are that they can be more reliable in that you know exactly what you are going to get and when you are going to get it. This allows you to depend on a steady payment each year and comfort that the chances are very, very slim that your initial investment will ever turn to nill, which is possible with other options such as stocks. On the other hand, the return is not usually as high as riskier investments. As always, we suggest a diverse portfolio that allows you to invest based on your risk-taking comfort level and allowance.

*Stay tuned for more Bond information coming soon to our Money channel!

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