You may have needed to borrow money from a friend more than once, whether it was at a coffee shop, the office, or even for a taxi. When you run out of money, most of the time the only thing you can do is borrow. If you did the same thing with big businesses and the federal government, you'd see that it's not that easy for them. Not only do they have to pay back the money they owe, but they also have to pay interest on top of that. Because of this, companies have to sign a "bond" that says they will pay back the money they owe. It is a formal way to make sure that payment will be made on time.
Before buying a bond, though, you should think about a few things. Let's take a quick look at some of the ways that investing in bonds could help you.
Before Investing
How a bond works mostly depends on whether you want to put money away for a long time or a short time. Also, it depends on your tax situation, the time, and what you want to do with the money. Before putting money into anything, you should think about some basic strategies. For example, it wouldn't be a good idea to put all your assets and risks in the same asset class. It is better to spread out the risks by putting together a portfolio of several bonds. By buying bonds from different issuers, you could protect yourself from the chance that one of the issuers won't be able to pay back the money they owe.
After Investing
After an investor puts money into a bond, the par value, or the amount of money the investor will get when the bond matures, is calculated. This means that the investor should be given back the money that is owed. The coupon rate is the amount the bondholder gets back as a percentage of the bond's face value. Lastly, a maturity date is set, which is the time when the bond issuer has to give the lender back the principal amount.
To find out how much a bond would yield, you could divide the interest paid over a year by the price of the bond at the moment. Bond prices change over time, so the current price is always taken into account. But if you want to sell before the maturity date, you should do so at the current market rate.
Different kinds of bonds
There are many different kinds of bonds. For instance, government, corporate, agency, mortgage-backed securities, municipal, etc. There are also bonds with different lengths of time until they mature. These help manage the risk of interest rates.
The US government sells treasury bonds with maturity dates that range from 3 to 5 months to 30 years.
On the other hand, corporate bonds are sold on public security markets. They are a bit risky and have high interest rates.
Local and state government bonds have higher interest rates than federal government bonds because they are more likely to go bankrupt than the federal government.
Buying foreign bonds is hard, and most people do it as part of a mutual fund. Putting money into them, though, can be risky.
Even though some bonds may be risky or have a low interest rate, buying bonds is still a good idea because they are good investments. The owner of a number of bonds gets a good credit score and can show that he or she is financially stable.
