So we have already established the basics of bonds, what they are and what they could mean for you as you start the process of building out your portfolio. Now is the time to take this knowledge one step further as we explore the components and characteristics of bonds. – as these will be necessary skills to read and analyze bonds and to determine whether a bond is the right investment choice for you.
But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.
Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.
Bond Components and Characteristics
The words stocks and bonds are commonly mentioned in the same breath but they’re very different investments.
Bonds, as we previously discussed, are loan investments, which means an investor is actually loaning
money to an entity – like a company, government, or municipality.
A stock, on the other hand, is an owned investment. An investor that purchases a stock actually owns a piece of that company. When an investor buys a bond, they are loaning money to a company in exchange for regular interest payments.
So in short : when you buy a stock, you are buying ownership in a company.
Of course, whenever a loan is made, certain terms must be established upon acceptance, the same is true for a bond.
When a company raises money through a bond, it’s called a new issue. In a new issue, millions of dollars of bonds are commonly available.
Each bond usually has a face or par value of $1000. The face value is the cost to buy a single bond.
Interest received from the bond is called a coupon. For example, a new bond may pay a coupon of $50 a year. Because coupons are typically paid twice a year, an investor should expect $25 every six months.
So a bond that has a coupon of $50 and a face value of $1000, has a coupon rate of 5% – this is the interest on the loan.
The loan agreement ends when the bond reaches maturity. Maturity is the length of time on the loan and is also the point at which your invested principal is returned to you. Bond maturities range anywhere from one to thirty years. At maturity, the investor has their initial investment or principal returned to them.
Loan investments with maturities less than a year are usually referred to as commercial paper or bills.
Bonds with maturities of 1-10 years are sometimes referred to as notes.
And bonds of 10 – 30 years are simply bonds.
Some bonds can be paid off early – these are known as callable bonds. You may here the phrase of a bond “Being called away” every once in a while.
Callable means that after a certain period of time, the bond issuer may return the invested principal back to the investors, paying off the loan early.
The investor will keep all interest paid to that point, but won’t expect any more coupon payments after the original principal is returned.
The company will pay the investor interest usually on a semiannual basis in the form of coupons.
The interest provides regular and consistent income for the investor until maturity which may be anywhere from one to as much as 30 years, depending on the bond purchased.
However, income is subject to the credit risk of the issuer of the bond. If an issuer defaults, no future income payments will be made.
Keep in mind, not all bonds are the same.
Some come as secured or unsecured proving varying degrees of protection.
Some issuers have varying credit ratings.
And some carry different interest rate structures that offer various repayment schedules. Investors should keep this in mind before investing.
Characteristics Of Bonds
- Bonds are loan investments, which means an investor is actually loaning money to an entity – like a company, government, or municipality
- When an investor buys a bond, they are loaning money to a company in exchange for regular interest payments.
- New Issue – When a company raises money through a bond
- Face Value – The cost to buy a single bond. Each bond usually has a face or par value of $1000
- Coupon – Interest received from the bond. Company pays investors interest on a semiannual basis
- Coupon Rate – This is the interest on the loan
- Maturity – The length of time on the loan and is also the point at which your invested principal is returned to you. Maturities range anywhere from one to thirty years
- Commercial Paper Or Bills – Loan investments with maturities less than a year
- Notes – Bonds with maturities of 1-10 years
- Bonds – Bonds of 10 – 30
- Callable Bonds – Bonds that can be paid off early
- The interest received (in the form of coupons), provides regular and consistent income for the investor until maturity – which may be anywhere from one to as much as 30 years, depending on the bond purchased.
- Credit Risk – The risk that an issuer defaults. This means no future income payments will be made.
And those are the characteristics/components of bonds. You now have a better understanding of what bonds are and what they are made up of – making it easier for you to understand and interpret bond data. Of course, there are more advanced topics and concepts that we will discuss in further detail as you continue through your investment training here at Invest In Wall Street.
I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.