Introduction to Bonds
Bonds are basically loans issued by the government or a corporation, where the investor is the lender. In return, the bond issuer will pay the bondholder interest at a fixed rate over a predetermined period, agreed on at the time of purchase. This interest rate is known as a coupon. The investor will then get back the borrowed amount, also known as face value, par value or principal amount, on the maturity date, the date of which repayment was agreed on.
For example, John purchases a bond from a corporation of $1 million at a coupon rate of 2.8% per annum that matures on 1st January 2020. John is now the bondholder, and receives 2.8% of the face value from the corporation every year until maturity. At maturity, the corporation will pay John back the face value.
Why invest in Bonds?
Bondholders enjoy a fixed payment regularly until the bond matures, which is a form of passive income. This is especially important for retirees or the unemployed.
Unlike stocks (equities), there is certainty in the amount to be received upon maturity. Bonds not only keep their face value, but deliver interest on it as well.
As opposed to stock investors, bondholders are paid first in the unlikely event that a corporation encounters bankruptcy. Also, bond prices are far less volatile compared to stocks, which means you can use bonds to diversify portfolios and manage investment risk.