A bond is a debt instrument that is designed to raise capital by borrowing the money of investors. Bonds are a type of fixed-income security whose payments are known in advance. There are three key elements of a bond that determine its value and whether it is suitable for you.
The maturity date of a bond is the date on which the issuer will repay your principal. The institution that sells a bond guarantees to repay the principal by a set date. A bond that matures within a shorter time will be less risky than one with a longer maturity date because its price will not fluctuate as much. Bonds that mature more quickly will generally pay a lower interest rate. (reference 2)
The principal, also known as the par value or face value of a bond, is what a bondholder will be repaid on the maturity date. This amount is different from the price of the bond, which changes during its lifetime, according to Investopedia. It sells at a premium if the price is above the face value; it sells at a discount if the price is below face value. The par value of corporate bonds is usually $1,000, but that of government bonds can be more.
The bond coupon refers to the amount paid as interest at regular intervals, which is usually every six months. Other possible intervals are monthly, quarterly or annually. A 20 percent coupon on a bond with a par value of $1,000 will pay $200 dollars a year. A fixed-rate bond like this has a rate that remains a fixed percentage of the par value. A floating-rate bond has a rate which changes with a specific index, such as the interest rate on Treasury bills.
Institutions that commonly issue bonds include governments, cities and corporations. They issue bonds when they need money for reasons such as construction projects and capital expenditures. The value of bonds are less volatile that that of stocks. US government bonds are considered the least risky because there is little chance of default. Corporate bonds are riskier, so they typically have a higher interest rate. Issuers with with high ratings such as AAA or AA are considered safe, while those with C ratings are considered very risky.
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