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Table of Contents for Bonds and other Fixed Income Securities
As an investment, bonds are riskier, but pay a higher interest rate, than money market funds or demand deposits or checkable deposits, but are safer than stocks, and usually less profitable, because they have no potential for growth.
Bonds are long-term debt or funded debt, issued by corporations, and governments and their agencies to finance operations or special projects. Corporations pay back interest and principal from earnings, whereas governments pay from taxes, or revenues from special projects. Unlike preferred stock, a corporation must pay interest on its bonds, and if the corporation goes bankrupt, bondholders are paid before any stockholders.
All bonds have a par value, an interest rate, and a maturity date. The interest rate is often called the coupon rate, because many bond certificates have coupons that the bondholder must turn in to receive the interest. In a primary offering, the investor buys the bond for par value. This money goes to the issuer. Periodically, the issuer pays interest to the investor, which is calculated by multiplying the par value by the interest rate divided by the number of payments in a year. Example: if the interest rate is 6% and the par value is $1,000, then the interest earned annually is $60. If the company pays interest semi-annually, which most do, then the bondholder will receive 2 payments of $30 every year until maturity. When the bond matures, then the current owner gets back the par value of the bond. In other words, the loan is paid off. Because the amount of interest the bond pays is fixed, bonds are a type of fixed-income security.
Bond maturities vary widely. Long-term bonds mature in 10 to 30 years or more; intermediate bonds have maturity dates greater than 1 year, but less than 10 years; short-term bonds mature in a year or less. Generally, the longer the maturity date, the greater the interest rate for a given risk class. Such a relationship is sometimes called the term structure of interest rates.
The indenture, or deed of trust, is the legal agreement between the issuer and the bondholder, printed on the bond certificate, and specifying the duties and obligations of the trustee (usually a bank or trust company hired by the issuer), and the rights of the bondholder. The indenture specifies how and when the bond will be paid, the interest rate, the description of any property used as collateral, and what the bondholder needs to do if the corporation defaults. The trustee represents the bondholders in dealing with the bond issuer, and will bring suit if interest payments are not made.
Introduction to Bonds
Bond Yields, Credit Risk, Taxable Equivalent Yield (TEY)
Special Bonds - Advanced Refunded Bonds, Put Bonds, Convertible Bonds
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