Before investing in bonds, you must understand some things about bonds. Understanding what kind of bonds to purchase, what maturity date to purchase, is necessary before you begin to invest in them. Par value, maturity date and coupon rate. These three characteristics of a bond are the most important things to consider before purchasing a bond. Buying a bond without thoroughly studying these characteristics of a bond is the surest way to make the wrong decision.
The par value of a bond refers to the returns on your investment once the bond matures. It is the amount of money that you will receive at the maturity date. In other words, when buying a bond, it is important to note that you will be receiving your entire investment plus interest only at the maturity date. This is the bond's par value.
Naturally, the maturity date refers to the date that your bond reaches its full value. This is the date that you receive all the returns of your investment. However, when purchasing corporate, state and local government bonds, you do not need to wait until the maturity date before you obtain the money back. Such bonds can be 'called' before they reach the maturity date. When the bond is called, the corporation or government issuing the bond will return your investment as well as any interest your bond has earned up to that point in time. However, federal bonds are unable to be 'called'.
The coupon rate refers to the interest rate. This determines the amount of money that you will receive when the bond matures. This is specified as a percentage. For example, a bond with a $1000 par value with a coupon rate of 10% will earn an annual interest of $100 until the bond matures. Similarly, a bond with a $2000 par value and a coupon rate of 5% will also earn an annual interest of $100 until the bond matures. This is important to note as the different bond value means a different initial investment, even though the annual interest is the same.
However, many people still do not understand how to purchase a bond. This is because bonds are not sold by banks, but rather by the government. This makes things slightly more confusing for most people. However, there are two ways of buying a bond.
The first way, is to go to a broker or a brokerage firm. The broker is able to make the purchase from the government on your behalf. However, you are likely to be charged a commission fee. Shopping around for the lowest commission fee is prudent if you want to use a broker.
On the other hand, you can purchase bonds directly from the govnerment. This process, although more troublesome is not nearly as difficult as it used to be. With the introduction of the program called Treasury Direct, all your bonds can be purchased and held in one single account that you have easy access to. If you choose to buy directly from the government, you can avoid using a broker and thus saving on the commission.
How Do Bonds Work
When the economy is in trouble, the stock market is often hit hard. When people fear the stock market, they look into how do bonds work to find safer investments. In learning how do bonds work, they hope to find a guarantee investment that they can safely put their life long savings.
There is not just one type of bonds, as you will learn when you study how do bonds work. Although, the specifics of each type of bond affect your bond investment, you need to learn the basics of how do bonds work before you even consider what type of bonds to invest in.
Bonds are debt investment, not equity investment. Bonds are issued to raise capital for the issuer. In learning how do bonds work, you will learn about bonds, who issue them, how they are issued and how to analyze them. Bonds are issued at par value or face value which is usually $1000.
Bonds can be sold at discount, at par or at premium. Discounted bonds are sold at prices below the par value or face value but the redemption value is always face value. Bonds can also be sold at premium prices which are above the pay value. The redemption value of a premium bond is still the par value. And, of course, bonds can also be sold at face value.
In learning about how do bonds work, people are most interested in finding out what interest rates the bonds pay. The higher the interest payments, the more popular the bonds are. The interest rate is also called the coupon rate. Bonds pay interests regularly according to the terms of agreement of the bonds. Interests are often paid monthly, annually or quarterly.
The coupon rate of a bond is the interest rate but a high coupon bond is not always the best bond to buy. When you learn about how do bonds work, you will learn about how to calculate the bond yield which is a better measure of whether a bond is a good investment or not.
The higher the yield, the better the bond. If bond A has higher yield than bond B, bond A can be better than bond B even if bond B pays higher interest rate. You need to learn all about bond yields when you learn about how do bonds work.
Finding out how do bonds work is key to bond investing especially if you are a beginner. Bonds are long term investments and should not be used for short term cash accumulation. You will learn about the right ways to invest in bonds in any books that teach how do bonds work.
Both Ryan Ginster & Harold Urich are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
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