Bond Investing

A bond is a type of debt. It's a loan from an investor to an institution, and in exchange the investor collects a predetermined interest rate. When a company needs capital to expand its business, it issues bonds to the public. Investors buy them with the understanding that they will collect the original principal plus interest when the bond matures at a set date. Federal, state, and municipal governments issue bonds for a similar purpose, to raise money for projects and public programs.

How Bonds Work
Think of a bond like an IOU. The lender is an investor, individual or institutions - and the borrower is an institution whose stability determines the interest rate it must pay on the bond. This is determined by the company's credit rating - the higher the rating, the lower the interest rate on the bond. This is because a bond's interest rate is determined by risk.
If the investor is relatively certain to get back the bond's principal on the set maturity date (say, three or five years in the future), then the interest rate on the bond will reflect that it's a low-risk investment. Some low-risk bonds include Treasury bonds and corporate bonds issued by large public companies. Other bonds, however, carry higher risk - these include junk bonds and mortgage-backed securities. These bonds have higher interest rates, reflecting the greater risk that investors take on when buying them.

Types of Bonds
Asset-backed securities
Convertible bonds
Corporate bonds
EE bonds
Extendible and retractable bonds
Foreign currency bonds
High yield bonds
I bonds
Mortgage-Backed Securities (MBS)
Municipal bonds
Savings bonds
Treasury bonds
U.S. Savings bonds
Zero-coupon bonds

Bonds or Stocks?
Making the choice between stocks and bonds can be complex. In general, though, the key consideration is your own planning horizon.
Bonds are, in general, more predictable than stocks, and (on average and in general) give you lower returns. If you believe you'll need predictable access to money over, say, a 20-year period, you may be better off with bonds. For example, if you want to put aside a specific amount of money for a grandchild, expecting that money to be available for college in eighteen years, and not expecting to have other capital available. Insurance companies invest heavily in bonds for just this reason: it matches predictable liabilities (future insurance claims) against predictable cash flows (principal and interest).
Some bonds have tax advantages; for example, municipal bonds are typically exempt from state taxes in the state that issued them, as well as federal taxes. This can make them more attractive, though often you will find that the market has arbitraged away the difference, and that corporate (that is, taxable) bonds carry a higher gross yield -- and the same net yield after taxes. Although many investors invest in munis for just this reason -- they "don't like the taxman" -- they may not be making the optimum investment choice.
Bonds are not riskless, however. They carry credit risk ("will I get my money back?"), prepayment risk, liquidity risk and interest-rate risk. Many bonds give the bond issuer the right to repay the bond early -- which happens more often when rates are low, in other words, just when you don't want your money back. This is prepayment risk. Liquidity risk is the risk that you won't find a good price for your bond when you want to sell it -- because there are so many more bond issuers than stock issuers, and because bonds are not exchange-traded, there may not be a willing buyer. Interest-rate risk is the opposite of prepayment risk: when rates go up, the value of your bond will drop (it drops more, the further away it is from maturity). If your circumstances change and you need to sell the bond before maturity, you can lose capital that you would otherwise receive, if you held the bond to maturity.

Investing 101

Asset Classes
Stocks Bonds Money Market Funds Private Equity Real Estate



What is a stock?

stock is a security that represents ownership in a publicly traded company and is sold by the share. Each of these shares denotes a part ownership for a shareowner or shareholder of that company. Stocks are traded on exchanges all over the world, the largest is the NEW YORK STOCK EXCHANGE or NYSE. Stocks are identified by their ticker symbol. For example, General Electric is identified as GE. Individual Investors can purchase shares for themselves, at a brokerage of their choice, wherever they have an account set up. There are different types of shares, common and preferred. Most shareholders will purchase common stock. The goal is for the price per share to increase over time so the investor can have a profit that beats monies in Treasury bills or beats inflation. Over time, stocks have outperformed cash and bonds, this takes into account depressions, world wars and other world changing events.


Common Stock
Common stock, also known as ordinary shares and common shares, grant the holder a proportion of the company's dividends and voting rights. Shares that are traded and bought by retail investors are usually shares of common stock. This kind of stock reflects the basic ownership of the company and is subordinate in claims to preferred shares and other dilutive securities. This is because by purchasing a common stock, you are effectively an owner of the company which makes you a servant to other investors who have a claim on the company through debt or derivatives.

Preferred Stock
Preferred stock is special stock sold to particular institutions or individuals that grant the holder priority over common stock holders in terms of dividends and bankruptcy claims. The drawback is that preferred stocks usually have no voting rights. The price of preferred stock in a company will usually differ from the price of common stock, a reflection of its different rights and privileges.