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Bond Basics

What is a bond?
A bond is basically just an official IOU. Everyone has had to borrow money at some point in their life. Well, the same goes for corporations and governments. When you buy a bond, you are lending money to some entity like the government. The problem is that when a government or coporation needs to borrow money, it is usually more than they can get from a bank. So what do they do? They issue bonds to the public. In return for the loan the entity promises to pay you a rate of interest over the life of the bond and to repay the principal after a set time. The interest rate is usually referred to as the coupon and the date that the entity has to repay the principal is called the maturity date. The bottom line is that a bond is just a loan for which you, the investor, are the lender.

What is the difference between a bond and a stock?
Though they are both investment related they are actually very different things. Stocks are equity in a company where as bonds are debt that a compay owes. When you invest in a stock, you buy a piece of the comany. When you buy a bond, you loan a company money. The bond is basically the less sexy younger sibling to stocks. Bonds are especially boring compared to stocks during bull market times because they offer much lower returns than stocks.

What is an advantage of bonds?
There are a few advantages of bonds. The first is that if a company files bankruptcy, a bondholder has a higher claim on assets than a shareholder. Secondly, a bond is fixed income. When you buy a bond you know the exact amount of money you will be getting and when you will get it.

What are the disadvantages to bonds?

The main disadvantage is that generally they do get much lower returns than stocks do. Also, if a company does very well, it makes no difference, you get paid the same no matter what. The bond is a very safe choice.

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