Understanding Bonds

Government, a company needs capital to expand their infrastructure and emerge in new markets. Money sitting at one place never grows. Capital that is being used is market is what helps to grow. Solution to this was borrow money and government and companies started borrowing the money in form of bonds.

No one is interested to give away their hard earned money. So, for lending their money lenders were provided interest on their money for the time period money is being borrowed.

Here is a sample of a bond:

source

Key terms used while dealing with bonds:

Coupon rate- It is an interest that bond will pay on principle like coupon with 5%  will yield 5% of principle however its compounded.

Maturity term- It is an term for which bond is issued on maturity as per agreement bond will be paid interest with principle.

Face value- Amount paid when a bond gets matured. it is also known as par value.

At premium- When a bond is traded above the par value.

At discount- when a bond is traded below the par value.

An example to understand how a bond works:

A bond is issued at 10% coupon rate annually and bond is of $1000. so if bond is issued on January 15, 2010. It will mature on January 15, 2020 and it will $1000 as principle and $100 as an interest.

Advantage of a bond is you become a creditor to the corporation or government when you buy a bond and you know amount you will get at the time of maturity and bondholders have first claim on assets in case of bankruptcy.

Risk in the bonds is minimum so they yield fixed low income.

source:http://www.investopedia.com/university/bonds/bonds1.asp

In last two posts Stocks and Bonds were covered at a basic level. As it is a vast topic a video here can help to understand it in depths:

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