A Consumer Guide to Understanding Bonds
A bond is a financial tool for government and corporations to borrow money from investors. Bonds allow businesses and city, state and federal governments to fund programs, projects and make long-term investments in public infrastructure. Likewise, corporations use bonds to generate the capital necessary to fund current operations and invest in growth.
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Issuer
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The bond issuer is the corporate or government entity that sells the bond in the financial marketplace. Bonds are not bought and sold directly from the issuer but through brokers in an organized setting like a stock exchange.
Bondholders
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Investors in bonds are called bondholders and act as creditors for the issuer. Unlike investors in stock, who own a part of the issuing company, bondholders own debt and not the company. As creditors, bondholders are compensated before stockholders if the issuer is bankrupt or liquidates assets to satisfy outstanding debts.
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Interest
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Bondholders receive regular payments from the issuer based on the size of the investment in a particular bond. These payments are commonly expressed as a percentage of the amount of money invested in a bond issue. Depending on the terms of the bond issue, interest payments occur monthly, quarterly, semi-annually or annually. Interest payments are the only return bondholders make from the investment.
Maturity
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Every bond has a maturity date where the bond principal and interest payments are due in full. For example, a 1 year bond means that the issuer can use the money for 1 year and the pays back the borrowed amount plus interest. Bonds are offered with maturities as low as a few weeks to 10 years or more.
Ratings
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Ratings agencies evaluate bond issuers to determine if bond issuers are able to make principal and interest payments. Low-risk bonds are granted a high quality rating while high-risk bonds are given a high risk rating. The SEC cautions that ratings are only opinions of the rating agency.
Municipal Bonds
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According to the Securities and Exchange Commission (SEC), bonds are available in different types. For example, municipal bonds, or "munis" are issued by local and state governments to fund public projects like hospitals, sewage systems and roads. Municipal bonds attract investors because the interest paid on the bond is not subject to federal income tax.
Treasury Securities
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The U.S. Department of Treasury issues bonds to finance government deficit spending. According to the Securities Industry and Financial Markets Association, Treasury bonds are considered low-risk because these bonds are backed by the credit of the federal government, which can raise taxes to pay off debt.
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