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In this video, I’ll discuss everything you need to know to understand bonds. Follow me on Instagram: ejgindis, and don’t forget to subscribe! Thanks for watching! -Elliot
Bonds are debt obligation securities, and stand in contrast to stocks, which are equity securities. A bond is simply an IOU from the issuer, or the borrower, to the bondholder, or the creditor, that says that the issuer will pay back the value of the bond plus interest. Bonds are first and foremost an instrument to borrow money.
Bonds are also referred to as fixed-income securities because the interest income they generate for the bondholder is usually fixed and predictable. Bonds are purchased and held by both private and institutional investors for the same reason banks make loans – to make money off the interest, and are considered an essential part of a balanced and diversified portfolio. In today’s low-interest environment they are looked at as a not terribly lucrative, but very safe investment as compared to stocks.
Bonds can be issued by the federal and local governments to fund regular operations or infrastructure projects, and by corporations to raise money for expansion or acquisitions.
Principal, Face Value, and Par Value. These terms are equivalent and they refer to the amount or value that is stated on the bond, and usually what you initially purchased it for. Another words this is the amount of money the bond holder “loaned” to the bond issuer. Bond principal amounts can vary widely. The smallest amount one can invest is $25 for a U.S. Savings Bond, and goes up from there to $100, $1000, $5,000 and all the way up to $10,000.
The next term is Maturity. This refers to the date when the purchased bond will be repaid in full. It can be thought of as the “length” of the bond. Maturities can vary widely from as little as a few weeks, all the way to 30 years or longer.
Coupon Rate and Interest Rate is how bond issuers pay for the privilege of borrowing money, and how bond holders make their money. The interest or coupon is expressed as a percentage of face value, so if the value of the bond is $1,000 and you are promised 5% interest, then the amount you will receive is $50 annually for each such bond you hold. Bonds usually generate interest payments every six months, but every month, quarter, or annual payments also exist.
Yield is the true payout of a bond. This is one of the more confusing aspects of bonds, and has to do with the price fluctuations. In essence, yield and interest rate are equivalent if the price is exactly the face value. So, for a $1,000 bond, paying a 5% interest rate, the yield is also 5%. However, if the price of the bond drops to $800, or rises to $1,200 the interest rate, which is fixed at 5%, gives a different yield with this new price.
Ratings is the grading of bonds, and refers mostly to corporate bonds as corporations can’t tax anyone to back up their bond issuances and must rely on good credit ratings to assure investors that the bonds will be paid back.
All gov’t bonds are called Treasuries:
Treasury Bills (T-Bills) – Maturity less than 1 yr.
Treasury Notes (T-Notes) – Maturity 2 yr. to 10 yr.
Treasury Bonds – Maturity greater than 10 years (typically 30)
The best way to purchase Treasuries is directly from the federal government at the website TreasuryDirect.gov.
The other government bonds are sold on a city or municipal level and are called Municipals or Munies. Munies are attractive to many investors due to most of them being tax exempt, and they fall into two broad categories: Revenue Bonds and General Obligation Bonds. Munies can be purchased from bond dealers, banks, brokerage firms, and sometimes even directly from the municipality itself.
There are two basic types of corporate bonds, short term ones, also called Commercial Paper and regular longer-term bonds, just called Corporate Bonds, and we’ll mostly just talk about them.
Corporate bonds are rated for quality. Some well-known rating agencies include S&P, Moody’s and Fitch, and they rate corporate bonds from AAA, to AA, to A, then B and all the way down to C and D which is junk status. The ratings have to do with the ability of the company to not default on paying back the bonds, and you want to stick to investment grade AAA or AA bonds as they are the safest and are issued by the strongest companies. Corporate bonds can be purchased from bond dealers, brokers or banks.
You can invest in bond mutual funds or ETFs. There are quite a few out there and they tend to specialize in only government or only corporate.
Link to ETFs Video:
There is a lot more to bonds, and they can get relatively complex. I didn’t talk about bond yields and pricing in any real detail, or what bond duration, convexity, and yield curves are. I’ll save those for an advanced bond concepts video to come at a later date.
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However the advantage of this is that these are excused from taxes – be it state or federal. Using the above technique, you lower the threat of investing too much at the incorrect time. The purity in karats should be marked on the bar.
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Individual Bonds This is the dollar worth of your share in the fund and the price that you pay whenever you get a quantity from the buying or selling of your shares in the fund.
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Bonds usually surpass other cost savings rates such as savings accounts and cash market accounts. With a typical interest rate of 5%, bonds pay almost double the rate of interest of the typical savings account. Purchasing these bonds is easy and use numerous benefits to financiers.
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