What are Bonds?
Bonds are a form of debt given by individuals to a government or an organization to finance a particular activity. A government may use this kind of instrument to finance infrastructure, projects or finance a budget deficit.
Companies on the other hand often through stock exchange issue bonds to the public with a guaranteed return. This makes one of the many finance options available to companies.
Risk averse investors use this investment option because they have a guaranteed return especially those issued by the government. Government bonds are considered risk free since the government is highly unlikely to default.
While other organizations or companies bonds are safe they may not be entirely risk free as they are dependent on the company’s performance. Less credit worthy companies issue their bonds at a higher return to attract investors. These bonds are sometimes referred as ‘junk bonds’.
The period of the bonds matters a lot since a 10 year period bond will earn more returns than a one year old. If you hold your bond to maturity you get its full value. However, you can buy a bond and sell it before maturity through a secondary market. When you sell the bond before maturity you get a value less than what you would have gotten at maturity.
The following are the most popular bonds:
Treasurys: These bonds are issued by the U.S. government and are considered the safest bonds on the market. You may not collect as much in interest as you might elsewhere, but you don’t have to worry about defaults. They’re also used as a benchmark to price all other bonds, such as those issued by companies and municipalities.
Treasury bill: Popularly know as T-bills, they are short term bonds maturing in several months. They are sold at a discount and you redeem it at face value on maturity.
Treasury Notes: They are issued in terms of two, five and 10 years and in increments of $1,000. Mortgage rates are priced off of the 10-year note (more commonly called the 10-year bond even though it’s technically a note).
Treasury Bonds: They are issued in terms of 30 years. They pay interest every six months until they mature.
Investing in bonds is one way to enhance personal finance