Investing in Bonds 101: Background
Part 1 or 3, page 1
To some people investing in bonds is somewhat of a mystery. What are they? Where do they come from? Who controls their issue? Will I get my money back? Can I lose money? This three-part coverage of bonds will answer these questions.
Typically people are use to investing in mutual funds or employer offered 401(k) funds over investing in bonds and feel a bit put aback when the subject comes up. Bond investing is just not as discussed in investing news. Some investors can more easily make the transition from investing in a mutual fund to investing in individual stocks than the transition to investing in bonds.
If this sounds like you hopefully you can change your mind after reading this introduction. What has been put together in this three-part article can help you.
First, you will learn some reasons companies issue bonds and other issuers of bonds. Terms surrounding bonds will be covered to help demystify them further. Later, after a discussion of bond terms, you will learn how to calculate bond yields, redemption features and credit quality, and bond ratings. Putting it altogether will allow you to start in investing in bonds.
Companies That Issue Bonds
Money is how a company expands or fund current operations. Larger corporations rely on several sources of funding for continued growth. When a company goes public and issues stocks, then they are agreeing to share a companies profitability with its investors who hold shares of stocks in a company. Holding shares of stock in a company is like taking part ownership in a company.
Another source of funding a company makes use of is bonds. When a company issues bonds it is asking investors to lend them money – as they are debt instruments. In exchange for lending money to an issuer of the bond, the lender is paid an interest rate, gets details about the frequency of payments and the length or term of the agreement, loan.
Bonds are issued in $50 to $10,000 notes. On the company's balance sheet they are listed as liabilities. How much money a company raises via stocks versus bonds is an important measure and how leveraged a company is said to be. This will be discussed a little more in bond ratings later.
Types of Bonds
Bonds pay interest to the holder of the bond at a predetermined frequency or at the end, when it matures. From an investor's point of view, a bond provides a fixed income because they can count on regular payments, the same amount at regular intervals. For example, an investor holding $1,000 in bonds with an interest rate of 5% would receive payments of ($1,000 x 5% =) $50 annually or $12.50 every quarter – which is how bonds usually pay out. [Keep in mind that this is a very simple example.]
There are four basic types of bonds which the average investor can choose from. Each of these bonds is defined by who issues the bond which also defines the bonds terms.
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