Important Things to know about Bonds
Before you buy a bond, you should investigate three important factors.
- The organization issuing the bond.
While all bonds have a maturity date, the ability of the Issuer to repay your initial investment will depend upon the financial condition of the organization. This is known as "credit risk". The bond market helps investors understand an Issuers credit risk through several bond-rating systems. For example, the US Government, who has historically always repaid a bond's principal at maturity, has a high likelihood of meeting its obligations and therefore has the highest bond rating. On the other hand, high risk companies are rated the lowest and their bonds are known as junk bonds.
- The bond's interest rate (or coupon) paid to the Bondholder.
Expressed as a percentage, the interest rate is the amount the Bondholder will receive as interest payments, usually every six months. A bond's interest rate is a reflection of the quality of the bond (the higher the quality, the lower the interest rate) and the length of maturity (the longer the maturity, the higher the interest rate).
- The bond's maturity date.
Bonds generally have maturity dates ranging from 1 to 30 years. The longer a bond's maturity date, the more risk that bond is considered to have. Longer maturity dates mean the Issuer has increased default risk considerations and interest rates have an increased opportunity to rise with a corresponding reduction in price.