A bond is a financial instrument in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a fixed interest rate. The entity that issues the bond is the borrower (issuer), and the bond holder is the lender. Bonds are commonly referred to as fixed-income securities and are one of the three main asset classes, along with stocks and cash equivalents.
Bonds are issued by companies, municipalities, and governments to raise capital. The issuer promises to pay the bondholder a fixed rate of interest (coupon) during the life of the bond and to repay the principal (face value) of the bond when it matures. The bond’s term, or maturity, can range from a few months to 30 years or more.
When an investor buys a bond, they are essentially lending money to the issuer in exchange for regular interest payments and the return of the bond’s face value when it matures. The bond’s interest rate, also called the coupon rate, is determined by the issuer at the time of issuance and is fixed for the life of the bond.
Bonds are generally considered to be less risky investments than stocks, but the risk of bond investment varies depending on the creditworthiness of the issuer and the bond’s terms. Government bonds, for example, are considered to be among the safest investments because they are issued by sovereign nations with the power to tax its citizens to repay bondholders. On the other hand, bonds issued by companies with poor credit ratings are considered to be high-risk investments.
Bonds can be traded on secondary markets, and their prices fluctuate based on interest rates and the creditworthiness of the issuer. When interest rates rise, bond prices fall, and vice versa.
In summary, bonds are a type of debt security that allows investors to lend money to an entity in exchange for regular interest payments and the return of the principal at maturity. They are considered to be less risky than stocks, but the risk varies depending on the creditworthiness of the issuer and the bond’s terms.
View Full Answer Page: What is a Bond?