When you buy bonds, you’re essentially lending money to the bond issuer to Fixed-income, who has pledged to pay you interest and return your money at a future date. Although stocks receive more media attention than bonds, the global bond market is larger in terms of market capitalisation than the equity market. Global stock markets were valued at $74.7 trillion in 2018, according to the Securities Industry and Financial Markets Association (SIFMA), while global bond markets were valued at $102.8 trillion.
What Are Bonds And How Do They Work?
Bonds are financial instruments in which an investor lends money to a corporation or government for a specific length of time in exchange for regular interest payments. The bond issuer returns the investor’s money when the bond matures. Bonds are sometimes referred to as fixed-income because your investment earns fixed payments for the life of the bond.
Bonds are sold by companies to fund ongoing operations, new projects, and acquisitions. Bond are sold by governments to raise funds and to supplement tax collection. When you buy a bond, you become a debtholder for the company issuing the bond.
Many forms of bonds, particularly investment-grade bonds, are less risky than equities, making them an important part of a well-balanced investment portfolio. Bonds can help to mitigate the risk of more volatile assets like equities, as well as provide a constant stream of Fixed-income while protecting cash during your retirement years.
Understanding Bonds: A Glossary Of Terms
Before we look at the many types of bonds and how they are priced and sold in the market, it’s important to understand the following terms:
Maturity: The date on which the bond issuer repays bond investors for the money they have lent them. Bonds come in a variety of maturities: short, medium, and long.
Face value, often known as par, is the amount of money your bond will be worth when it matures. The face value of a bond is also used to calculate interest payments payable to bondholders. The most frequent par value for bonds is $1,000.
The fixed rate of interest paid by the bond issuer to its bondholders is known as the coupon. If a bond has a 3% coupon and a par value of $1,000, the bond issuer guarantees to pay investors $30 per year until the bond matures (3 per cent of $1,000 par value = $30 per year).
What Are The Different Bond Types?
Bonds come in a nearly infinite number of varieties. Investment-grade bonds in the United States are divided into four categories based on the institution that issues them: corporate, government, agency, and municipal bonds. These four bond kinds also have different tax treatment, which is an important factor for bond investors to consider.
Bonds Issued By Corporations
Public and private corporations issue corporate bonds to fund day-to-day operations, grow output, fund research, or finance acquisitions. Federal and state Fixed-income taxes apply to corporate bonds.
Bonds Issued By The Government
The federal government of the United States issues government bonds. Because they are issued by the United States Treasury Department, they are frequently referred to as treasuries. The money obtained through the selling of treasuries is used to fund all aspects of government operations. They are taxed at the federal level but not at the state or municipal level.
Bonds Issued By Government Agencies
Agency bonds are issued by government-sponsored enterprises (GSEs). Such as Fannie Mae and Freddie Mac to fund federal housing, education, and agricultural lending programmes. Federal taxes apply to certain bonds, while some are exempt from state and local taxes.
Bonds Issued By Municipalities
Municipal bonds are issued by states, cities, and counties to support local initiatives. Municipal bond interest is tax-free at the federal level and typically at the state level. Making them an appealing investment for high-net-worth individuals and retirees seeking tax-free income.