Many people assume that investing in bonds is simply buying stock in a business that makes money and then betting that the business will continue to do so. However, there are several other characteristics of bonds besides being an investment in company assets. The most important characteristics are worth, how they are classified, and what they are subject to.
Bond definition: A bond is typically a debt instrument that promises to pay a certain amount of interest over a certain period. Normally, bonds are offered by issuing companies, municipalities, or the government. Face value: Simply put, the bond’s face value is the amount that the issuer is willing to pay you back. It doesn’t matter if you purchased it “at market value” or a coupon rate. Face value is usually set at a price you will sell it for when you decide to exercise your rights to purchase it later. If the issuer decides to raise the interest rate, however, the face value will often be raised.
Category of bonds: There are two main categories of bonds, fixed-income and variable-income. A fixed-income bond will typically pay out the same amount of interest throughout the bond’s lifetime, regardless of the stock market changes. On the other hand, variable-income bonds can be affected by the ups and downs of the stock market. A variable-income bond may pay out more interest during good years and less during bad years.
Characteristics of a Bond Investor: First, an investor will need to qualify for a bond. Different types of bonds have different requirements. An investor looking to buy a bond should check with the better business bureau and the banks to find out if any complaints are filed against the company or if the lender has been fined for fraud. Most importantly, the buyer should ask about the bond terms, such as the minimum payment and the type of payment options available. Buyers of fixed income securities should use certified funds or self-certs to guarantee their purchases.
Types of Issues: There are two issues to choose from for investors interested in purchasing bonds. Issue buyers pay the issuer directly and issue bonds in bundles of one, two, or several units. Bond issuers are not required to issue bonds within a specific time frame, although they are encouraged to do so for their financial protection. Generally, it is more profitable to issue bonds within one year of the purchase date.
Types of Baskets: There are many different types of bonds to buy. The most common types are corporate bonds, municipal bonds, personal bonds, and other corporate-like bonds. To buy bonds, an investor usually uses a money market account that contains certificates of deposit. Individual investors can also purchase bonds, but typically at a discount. Most individual investors buy bonds within a four-year range, while larger institutional investors prefer to hold bonds longer.
Purchase of a Bond: Bond purchasers must first select the security they wish to purchase. They then apply to the primary dealers that market these securities, then present offers to the borrowers. The borrower reviews the offers and signs off on the deal. Bond buyers pay the seller a lump sum, or in some cases a fee, upon the settlement of the debt. The payment amount is based on several factors, including the yield on the bond itself and the interest rate applied to the principal.
The bond’s maturity date represents the actual date that the debt will be paid principal and interest. Usually, bonds mature between one and five years, but this is not always the case. A bond may only mature for a few months or a year at a time, depending on the credit rating of the issuing company. As the interest rates decrease, bonds can trade further in the market, enabling investors to obtain additional yields for their investments.