What Is A Bond?
A bond is a fixed-income instrument where an investor lends money to a company or a government for an agreed period for interest payments.
When a person purchases bonds in the bond market, they essentially provide a loan to the bond issuer. Bonds are investment securities under which the issuer owes the holders a debt. Depending on the terms, the issuer may pay the bondholders interest and return the money on a specific date in the future. A bond is similar to an I.O.U (I owe you). This is a document that acknowledges the existence of a debt in the sense that it includes the details of the loan and payments.
Governments and organizations often issue bonds to borrow money from the public to finance various projects. For instance, a state government may issue bonds to raise funds to build a local airport. On the other hand, an organization that wants to execute a project that costs more money than an average bank can afford to loan out may issue bonds to raise funds.
There are four primary types of bonds sold in the markets. They are:
- Corporate bonds: These are bonds by companies to raise funds for projects and acquisitions. Corporate bonds usually mature within 1 to 30 years. They offer a higher yield than government bonds but carry more risk.
- Government bonds: These are from the national government, and each country uses different terms to describe them. In the United Kingdom, government bonds are referred to as “gilts” and usually carry the maturity period on the name. For instance, a government bond that matures in three years is called a “three-year gilt”. In the United States, government bonds are referred to as “treasuries.”
- Municipal bonds: State or local governments issue these bonds. Holders of municipal bonds (or “munis” for short) receive interest income often, but not always, as exemption from federal and state income taxation.
- Agency bonds: Government agencies or government-sponsored enterprises (GSEs), federally chartered corporations publicly owned by stockholders, issue these bonds. Typically, the bonds are available through broker-dealers who purchase them wholesale at a discount and sell them to investors in the secondary market at a higher price.