Bond

A bond is a financial instrument that entails lending money to an organization for a predetermined duration.

Borrowers issue bonds to gather funds from investors who are willing to lend them money for a specified period.

When you purchase a bond, you are effectively lending to the issuer, which could be a government, municipality, or corporation.

In exchange, the issuer commits to paying you a designated interest rate throughout the bond's term and to returning the principal, also known as the face value or par value of the bond, when it matures, or becomes due after a defined period.

Governments (at all levels) and corporations frequently utilize bonds to borrow funds. Governments require financing for infrastructure projects such as roads, schools, and dams.

Corporations may issue bonds to expand their operations, acquire property and equipment, engage in profitable ventures, invest in research and development, or hire staff.

Bonds are classified as fixed-income instruments since they traditionally provide a fixed interest rate (coupon) to debtholders. However, variable or floating interest rates have also become quite prevalent.

While bonds are the most common type of fixed-income security, other examples include CDs, money markets, and preferred shares.

Bonds typically fall into four categories, depending on the type of institution receiving the loan.

Corporate bonds are issued by companies. Many companies prefer issuing bonds over seeking bank loans for debt financing because bond markets often provide more favorable terms and lower interest rates.

Municipal bonds are issued by states and municipalities, with some offering tax-free coupon income for investors.

Government bonds, such as those issued by the U.S. Treasury, are categorized based on their maturity: bonds with a year or less to maturity are called “bills”; those with 1–10 years to maturity are referred to as “notes”; and bonds with more than 10 years to maturity are simply called “bonds.” Collectively, bonds issued by a government treasury are often referred to as “Treasuries.” Bonds issued by national governments may also be known as sovereign debt.

Agency bonds are issued by government-affiliated organizations like Fannie Mae or Freddie Mac.

Bondholders are considered debtholders or creditors of the issuer.

The bond will specify its interest rate (known as its coupon) from the beginning.

Since your initial investment is returned to you upon the bond's maturity date, this is the sole profit that bonds provide.

Bond values are typically set at par, usually either $100 or $1000, representing the face value, or the amount that the initial investment will be worth at maturity. Interest rates are determined by the creditworthiness of the issuer and the loan duration.

Bond prices have an inverse relationship with interest rates: when rates rise, bond prices decline, and vice versa.

Bonds have maturity dates, at which point the principal amount must be repaid in full, or the issuer risks default.