What is a BOND?

What is a bond?

A bond is an IOU. When you "buy" a bond, you are lending money to an organization. The amount of the loan, called the "face value," is normally $1000. The organization promises to repay the loan on a fixed date, the "maturity date," and to pay interest until then at a fixed rate. The rate does not change during the life of the bond.
The interest, known as the "coupon," is paid at regular intervals usually semi-annually or annually. Zero coupon bonds pay their interest all at once on the maturity date. Some bonds are "callable;" the issuer has the right to pay the buyer back early. Other things being equal, callable bonds are less desirable.
Federal government bonds are known as "treasuries" or "T-bonds" (10-30 year maturities), "T-notes" (2-10 years), and "T-bills" (90 days -1 year). Bonds are sold by governments, states, counties, cities, corporations, and other organizations worldwide. The bond market is huge, much larger than the stock market.
A bondњs interest rate reflects both the general interest rates at the time of issue and the risk involved in lending the money. You will get a higher interest payment from a developing corporation than from the state of Florida; Florida is less likely to go out of business. General interest rates fluctuate gradually from low single digits to as high as 20% on rare occasions.
The interest rate on a given bond never changes. What happens to the value of that bond when general interest rates and the credit rating of the issuer change?

Bond prices

Bonds are often sold before they reach maturity. Bond prices rise when general interest  rates drop, and vice versa.
For example, if interest rates drop after a bond is issued, the bondњs value increases (assuming no change in the credit rating of the issuer). Why? Because, the owner of the bond is receiving larger coupon payments than new buyers of bonds that have the same face value but a lower interest rate. In the open market, increased demand for the older bond with its higher payment drives its price up until the new and old yields are in balance. The coupon payment amounts remain fixed and different on the old and the new bonds, but since a buyer is paying more for the old bond, its effective interest rate has dropped, bringing it in line with the general interest rate.
To further complicate the comparison, the secondary buyer of the old bond will receive the face value of the bond on its maturity date, not the price the buyer paid for it.
If you deal with bonds on a regular basis, the relationships of price, interest rates, and yield are easy enough to remember. Otherwise, every so often, you might have to step back, take a deep breath, and reason it through again. Bonds are fixed agreements; the world is constantly changing. The variable price in the market keeps them in sync.
Bond prices are quoted as a multiple of face value. For example, a $1000 bond quoted for sale at .97 will cost $970 (.97 times $1000) plus commission; a bid of 1.12 means that the bidder is willing to pay $1120. A bond quoted at 1 is said to be at "par." The buyer is paying par (face) value.

Why bonds?

Bonds are normally bought for their dependability. Owners know how much they will be paid and when. Treasuries are probably the safest of all investments.
Bonds are also traded for capital gain. An investor might decide, for instance, that the future for a country is bright, that its economy will strengthen, that its interest rates will eventually drop, and its older government bonds will rise in value. Or, a crisis in a corporation might cause its bonds to sell so cheaply that, if the corporation recovers, any buyers at that level will make a fortune as other investors regain confidence in the corporation and interest rates drop to normal levels.
In general, bonds offer a safer return than stocks, but less chance for capital gain. Portfolio advisors recommend a mix of bothЌmore bonds than stocks for the retired, more stocks than bonds for the young. Once again, the proportion must suit you.
Some investors prefer all stocks, some buy only bonds. An interesting strategy for the patient and thrifty is to save and to invest only in treasuries, a little more each year. U.S. treasuries can be bought directly from the government, paying no commission to a middle person (a broker). Waitresses, house painters, administrative assistants, and marine engineers have quietly achieved financial independence in this slow but sure way. There is a saying in the country: "It's not how much you make; it's how much you keep."