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Bond Basics

When you need cash, you go to the bank for a loan. When corporations and governments need cash to pay expenses, finance improvements or complete research, they issue bonds for sale on the bond market. The corporation or government is known as the "Issuer" and the bond buyer is known as the "Bondholder." In effect, each Bondholder is similar to the Bank where he or she "lends" cash to the Issuer in exchange for an I.O.U., namely a bond (also known as a fixed income security).

The Issuer, in exchange for the use of the Bondholder's money, pays the Bondholder a pre-determined interest rate with a promise to repay the principal at a pre-determined date, known as the maturity date. Bond interest payments are usually made every six months until maturity.

While bonds are designed to repay the Bondholder's initial investment at maturity, it is important to know that the proceeds from bonds sold before maturity may be more or less than the original investment. Bonds, just like stocks, are publicly traded and fluctuate in price. Interestingly enough, bond prices can be gauged by the direction of interest rates relative to the bond's yield. Trading on an inverse relationship, bond prices will rise and interest rates in the marketplace drop and visa versa. Obviously, if you plan to sell your bonds prior to maturity, the best time to sell is when new bonds are issued at yields lower than the yield on your bond.

 

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