What is a bond?
Bonds are considered to be the less risky of the two choices: Stocks and Bonds.
However, understanding exactly how bonds work is an interesting concept. Unlike stocks which you buy into the company, with a bond you actually are lending the money – you are the bank!
3 Types of Bonds:
1. Corporate bonds – this is when businesses and corporations are looking for lenders. They don’t want to go public and sell their shares or parts of their company publicly, but the do need money to borrow. Mostly it’s when they can’t get money from banks, they hire financial professionals to help with this public lending.
Corporations will borrow for a certain period of time and then pay a yearly interest rate on the loan until the bond matures.
This is considered the most risky of them all because you don’t know if the company will pay you back or they can fold. As with all higher risks, the rewards can be much higher.
2. US treasury bonds – this is when the United States Government is borrowing money from people. Considered to be the safest investment out there. There are a few benefits to this bond purchase – the greatest of all is that it’s tax exempt. You don’t pay any taxes on it’s gains.
The way these are purchased are usually in par value denominations ($1,000 bulk)
3. Municipal bonds – this is local governments asking for IOU’s with interest rates. Normally this is paid via the tax payers money that comes into the local areas.
The downside is that they are not guaranteed by the local government. The main benefit of this purchase is that they are tax exempt.
Plus, if you’re buying into a certain project let’s say money is needed for a new toll road, you are pretty much guaranteed you will get that money back since it’s a toll road and will not lose the money.
How the bond is paid off:
The company, government or municipality pays back in different time frames. This is called coupon rate or coupon yield.
Some can pay monthly, by-yearly, yearly or at the end of it’s maturity.
This information is known to the public when you purchase and you make the decision.
Benefits of buying bonds:
The risk is much lower, thus the rewards are lower. But if you buy well, you will always make your money back!