Bonds

A bond is simply an IOU. It is an agreement under which a sum is repaid to an investor along with interest (coupons) after an agreed period of time (maturity). By purchasing a bond you are lending money to the institution issuing the bond and become a creditor of the issuer. Such loans normally repay a fixed rate of interest (unlike equities) over a specified time and then repay the original sum in full after a fixed period when the bond matures. Bonds are generally issued by either the government, or a public company (corporate bonds). A bond holder has a greater claim on an issuer's income than a shareholder in the case of financial distress as they are a creditor.

Treasury bonds are generally considered the safest unsecured bonds, since the possibility of the Treasury defaulting on payments is so unlikely. However you will receive a lower interest rate.

The yield from a bond is made up of three components: coupon interest, capital gains and interest on interest (if a bond pays no coupon interest, the only yield will be capital gains). A bond might be sold at above or below par (the amount paid out at maturity), but the market price will approach par value as the bond approaches maturity. A riskier bond has to provide a higher payout to compensate for that additional risk. Some bonds are tax-exempt, and these are typically issued by municipal, county or state governments, whose interest payments are not subject to federal income tax.

Types of Bonds

Corporate Bonds

Government Bonds

Zero Coupon Bonds

Municipal Bonds

Junk Bonds