Bonds are contracted debts that obligate issuers to pay periodical interest and repay the principal at maturity.
Every bond when issued must state par(face value),interest rate,and maturity.
Bond issuance is announced publicly together with its Prospectus or Official Notice which is like a contract spelling out everything about the bond.Prospectus or Official Notice should be read carefully before deciding to buy a new issue.For example, ABC corporation announces today that the company issue $50 million of $1,000 bond with 8% interest rate fixed,semi-annual interest payments,and maturity on 07/01/2017.That is, the bond buyer pays $1,000 and receive $40 every six months on the dates 01/01 and 07/02.On 07/01/2017 he/she will get back the principal of $1,000.
For zero coupon bonds issuers do not pay interest but the bond will be sold less than par.For example,$1,000 par value bond with zero coupon and maturing in 10 years is sold at $615.That is,the buyer will pay $615,receive no interest payment but get $1,000 at maturity ten years later.The sales agent then writes in the sale confirmation Yield to Maturity 5%.
There are three main types of bonds: Corporate bonds-issued by corporations,Municipal bonds-issued by states or local governments,and Treasury bonds-issued by The U.S. Department of Treasury.
Issuers might default and bondholders would lose money so there are rating companies who evaluate the issuers’ creditability,the chance they may default,then assign the rating on the bonds.In general,the higher the rating,the safer the bond,but the lower the yield.
Three major rating companies are:Standard & Poor’s,Moody’s,and Fitch.For example,all Treasury bonds are rated AAA,the highest rating on S&P’s and Moody’s scales.All municipal bonds are investment grade bonds and rated from AAA,AA,A,BBB by S&P’s.Lower than investment grade are speculative bonds (or commonly called junk bonds) and rated BB,B,CCC,CC,C by S&P’s.Corporate bonds are rated from AAA to C.Default bonds are marked as D.
Bond price moves inversely with the market interest rate.If the market rate increases, the bond price decreases,and vice versa;however,the interest payments are always steady.
The best way to start with investing in bonds is choosing a bond fund which meet one’s investment objective such as the time frame,the percentage in the portfolio,the level of interest income desired,tax status and best of all bond fund provides diversification and professional expertise.