What is a Bond?

Along with stocks and cash investments, bonds are one of the three main asset classes. A bond is a debt investment in which the buyer of the bond loans money to the corporate or government entity for a defined period of time at a fixed interest rate. Bonds are used by companies and governments to raise money for a range of projects and activities. An investor who buys a bond is a creditor of the issuer, but not an owner (as a stockholder would be).

Commonly referred to as fixed-income securities, bonds are issued with the promise that the bondholder will be paid with or without interest at the end of a specified period. The issuer of a bond states the interest rate (the coupon) that will be paid and when the loaned funds (the principal) are to be returned (the maturity date).

Bonds may be secured (backed by collateral) or unsecured. A secured bond pledges assets that will be distributed to the bondholders upon default by the issuer.

Besides returning the principal, most bonds guarantee payment of interest at a specified rate. The rate of interest on the face amount (par) is referred to as the coupon rate or interest rate.

The main categories of bonds are:

• Corporate bondsare a major source of capital for many businesses’ operations (along with equity and bank loans or lines of credit). Because they’re considered higher risk than government bonds, their interest rates are almost always higher, even for top-flight credit quality companies.

• Municipal bonds, or “munis,” are issued by a state, municipality, or county to finance its expenditures. They are distinguished by the tax-exempt status they carry, and are therefore popular with investors in higher tax brackets.

• Treasuries refer to U.S. Treasury bonds, notes, and bills—the debt financing instruments of the U.S. federal government, which fully backs them.

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