How Bonds Work

By | August 27, 2013

My daddy bought me a government bond of the Third Liberty Loan, did yours?

If you have ever wondered what a bond is or the principles of how they work, understanding them might help you when it comes to making a decision about investing in them. The more information that you have regarding bonds, will mean a  better understanding, resulting in more informed decisions that you make, and this will mean that you will choose the right bond for you.

How they work

The concept of a bond has been around for a long time. They are used as a way to raise money. A company might need to expand and the amount of money is too large for a bank to fund so they sell bonds. These are little loans that they will pay interest on. The interest repayment schedule will be stated in the information that will relate to the bond. Interest payments can happen every month, year or end of term. With a bond there is always an end date and the bond money is paid back plus any interest on this pre-agreed date.

Terms

There are many different terms that are used and you should be familiar with them before you start to invest because you want to know where your money is going. You should know the terms that are associated with your bond so that you are fully aware of when and where you will be receiving your interest payments or your bond money returned in full.

The interest rate that you will receive is often referred to as the coupon and this rate is normally higher for the longer term bonds, or the more high risk options.

The term of the bond is the length that you have agreed that the company can have your money for. You can get some short term bonds that are a year or less or the long term bonds of five or more years, there are even bonds that have the term of fifty years.

The term capital refers to the money that is being invested into the bond, whilst the term often means the length of time that the money will be invested for.

Risk

There are different risks for all bonds and they can depend on a number of different factors. Bonds are considered a lower risk than some investments but there is always some form of risk with any investment. A government bond is considered the lowest form of risk, but with this comes a lower rate of return.

Why they work

The reasons that bonds are still around is because they work, and they work well. They give corporations the funds that they need to grow and develop whilst at the same time repaying the investor with interest as well as repaying the capital. It is a simple idea and one of the easiest ways to invest money, but as with any investment do your homework before investing in any bond. You need to make sure that it is the right bond for you, that it fits yours needs. Only then is it wise to invest in the chosen bond.

 

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