Introduction to Bonds

When investors purchase bonds from a company, they are basically investing in the company in order to receive a predetermined interest rate.  Companies issue bonds to raise money for operating expenses or for business expansion.  Investors buy the bonds, and in exchange- receive interest on the amount of their bond purchase for a set period of time.  It's similar to a bank mortgage- except in the case of buying company bonds, the investor becomes the bank! 

Another way to think about bonds is to consider them an "IOU".  You are purchasing the bonds, therefore loaning the company money,in exchange for interest payments on the amount of money they "owe" you.  Bondholders receive a check at the predetermined intervals (monthly, quarterly, annually, etc) until the "loan"  and the interest, has been paid off.

Why Invest in Bonds?

Bonds can't compete with stocks over the long term, as far as their potential for a growth of income, so why would anyone want to invest in bonds?  Bonds have some unique advantages that you won't find in the stock market.

• Preservation of Capital.  When you invest in the stock market, you don't always know what will happen.  You could lose it, or you could have great results- but there is always a risk.  Bondholders have a much lower risk, and will almost always receive the amount originally invested; unless the company declares bankruptcy.
• Interest Payments.  Particularly in the case of individuals on fixed income, or people needing additional cash flow, bonds can provide much needed cash.  Bonds pay interest to bondholders over a set period of time, and at predetermined intervals.
• Possibility of Tax Advantages.  If an investor buys government issued bonds that are used to raise money for bridges or roads for example, the interest the bonds earn is exempt from taxes.

Bond Types

There are many different types of bonds, in addition to the company issued bonds used to raise capital for the business. While all bonds are considered less riskier than the stock market- each type of bond has a different level of risk associated with it. Some bond types include:

• Commercial Paper:  Unsecured debt used to finance short-term requirements for businesses with high credit ratings.
• Convertible Bonds:  Bonds that can be converted into a share of company stock.  Great profit opportunities.
• Corporate Bonds: Safe returns, higher interest rates than CD's or Money Market Accounts.
• Municipal Bonds: Tax exempt bonds issued by government to build roads, buildings, water treatment plants, etc.
• Savings Bonds: Risk-free investments, guaranteed by the United States government.  Several different types exist.
• Zero Coupon Bonds: Does not pay interest payments, is redeemable in full on maturity date.
• Junk Bonds:  Higher risk bonds that pay higher returns.

Bond Rating Agencies

Bond investors should consult with one of the bond rating agencies before purchasing bonds.  These agencies, including Moodys and Standard & Poors, provide you with information about how to read a bond rating, as well as lists of bond ratings for the different types of bonds you could invest in.