A Beginner’s Guide to Bonds

Introduction

Loans are typically requested from a financial institution such as a bank and given to the borrower to support their monetary responsibilities. These loans are usually paid in portions with added interest on a monthly basis. Bonds work in a similar manner to loans, however the distinct difference between the two is that when purchasing bonds, you are loaning out money to the government or a corporation and they pay you back with added interest. 

Loan vs. Bond

Loan – Money is given to a person from the bank. The given amount is expected to be paid back monthly with the addition of interest.

Bond – Money is loaned out to a company from a person. The company returns the given amount with interest.

Characteristics of a Bond

Bonds, similar to stocks or mutual funds, are an example of a financial asset. It's a resource that individuals invest in to diversify their investment portfolios.

Like loans, bonds have an interest rate. The longer you choose not to cash out a bond, the more interest is collected, which will result in a higher profit.

When purchasing a bond, you are mailed a certificate from the entity that issued you the bond. This certificate is a legal document given to the investor with the terms and conditions of the bond written on it.

Common Types of Bonds

Treasury Bonds: A treasury bond, also known as a governmental or sovereign bond, is a bond that gets issued by the government. These bonds are backed by the credit of the government, making them an extremely safe investment. Treasury bonds are exempt from local and state tax, however still included in federal taxes. These bonds also typically have the longest maturity rate, lasting ten to thirty years. (Maturity means the date at which the bond will be fully paid). 

Municipal Bonds: These types of bonds are issued by local, county or state governments. They are offered when major construction projects arise and require large amounts of funding. Oftentimes when the proposal of a new highway or school is being developed, bonds will be promoted to secure the proper funding is available. These types of bonds are very popular due to them being tax exempt, meaning they are not included in federal income taxation.

Corporate Bonds: A corporate bond is an asset that can be acquired when a corporation is trying to expand their business. These bonds are purchased to assist in financing large operations that are ongoing in a company. Corporate bonds are often seen as a risky investment due to the chance of the company that issued the body falling into a bankruptcy and losing all of their equity, meaning they would be unable to pay back the original investment.

Conclusion

To summarize the findings in this article, Bonds are a popular financial asset that are commonly invested in to diversify a person’s investment portfolio. Bonds function the same as a loan, but are paid government to person instead of person to the bank. The three major types of bonds are Treasury, Municipal and Corporation. All three are offered when a major project arises and funding is needed, however they each have their differences. From tax exemption to long maturity rates, these bonds could be no different from each other.