What are Bonds?
A bond is a financial product that allows an investor to lend money to a company or government. The company or government issues a bond that is essentially an IOU, which is then purchased by investors. Investors will receive the full amount (principal) at the expiration of the bond (maturity), along with an interest rate for the duration of the bond (coupon). Bonds are used for financing purposes and the most commonly known ones are:
- Corporate Bonds - issued by companies
- Municipal Bonds - issued by a city or local government
- Government Bonds - issued by governments, i.e. US Treasury Bills
The maturity on a bond can range from 3 months to 30 years and the interest rate usually increases with the maturity of the bond (known as the yield curve). Bond prices and interest rates are negatively correlated so as the price of a bond falls, the relative yield rises ($5 interest payments on a $80 bond yield relatively more than on a $100 bond). Regardless of the actual value of the bond, it is always referred to as 'par', and all future prices are denoted accordingly as a percentage of the original value.