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Bond

A Bond is a security issued by a business, municipality, government, or government agency that promises the “bondholder” a contractually defined schedule of interest payments and principal repayments.  The issuing entity must meet their obligation as defined within the covenants of the bondholder agreement before any distribution of assets can be made to stockholders.

Bonds make interest payments through “coupons”, which are typically paid twice per year.  Some bonds, called “zero coupon bonds”, do not pay any coupons and, instead, make a single payment upon maturity which includes both the return of principal and the cumulative interest payments – zero coupon bonds are therefore bought for an amount less than the maturity value.

The yield of a bond will reflect the risk that investors believe are associated with the bond; the greater the risk, the higher the yield.  Bonds that have very high yields, and high risk, are often referred to as “high yield bonds” or “junk bonds”.

Bonds are also available under a wide range of maturity dates, typically ranging from a few months to 30 years.  Typically, longer term bonds will pay higher interest rates for the right to hold on to your cash for longer periods – the relationship of interest payments to maturity values is often represented by what is called a “yield curve”.

Other features of bonds that should be considered before investing include:

Callability – a callable bond gives the issuer the unilateral right to repay the principal to the bondholder at a time prior to the schedule maturity date, usually after a specified period of time has elapsed.  This can be advantageous to the issuer if interest rates decline in the future, and also increase the risk to the bondholder.  As a result, callable bonds pay higher rates of interest than an otherwise comparable bond.

Convertability – a convertible bonds gives the bondholder the right to exchange their bond for a specified number of shares of common stock.  This can be advantageous to bondholders if the price of the common stock increases; this option therefore results in lower yields to bondholders than an otherwise comparable bond.

 

 

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