Do You Know What A Bond Is?
When you needed something and you didn't have the money to buy it, what did you do? You went out, borrowed, bought whatever you wanted, and then hopefully returned the money with interest.
Well, companies and corporations need money too, to expand, to improve their technology, to hire more staff, and so on. Most commercial enterprises need money for various things to run their business. Unlike you or me, commercial ventures have a choice when it comes to borrowing. They can borrow from the bank or they can release more stock into the market. Or, they can borrow from you and me. This is really what a bond is all about. The people lend the money and they get a bond in return. This bond really is a promise that they will get paid back.
The bond has a face value that is fixed, a coupon rate or an interest rate, and a maturity rate. You pay the amount that is the face value and the company pays you the coupon rate or the interest at regular fixed intervals. Then on the date specified which is the maturity date, the principal or the amount on the bond is paid back.
The strange thing is, considering bonds are so straight forward, simple, and safe, why are they still lurking in the background and not taking their rightful place in the realm of investment options? It could be that because they are so staid and safe, they are not newsworthy enough so not much is heard about them. Let's look at some numbers: the Treasury Securities in the US trade nearly $360 billion every day. The total stock market is $20 trillion and the NYSE is $8.5 trillion. And we go further to see that the Foreign Exchange market does around $1.5 trillion every day.
So bonds may not be the darling of the press but the fact remains that bondholders get paid even before company owners in case of bankruptcy. Then again, there are tax waivers when you invest in bonds. Further, bonds can be calculated and are so much more objective. It is much easier to predict their future price as well. Say there is a 4% interest rate right now and the bond carries an 8% coupon rate, obviously it will sell higher than the face value. The big advantage of bonds is for the investor to be able to calculate and to make an informed decision. When other investment options may be too volatile for a shorter investment timeframe, then bonds can rise from the staid to be quite exciting.