A bond in the stock market is a debt security issued by corporations or governments to raise capital. Investors who buy bonds lend money to the issuer in exchange for periodic interest payments and the return of the principal amount at maturity.
Bonds operate as loan agreements between the issuer and the investor. The issuer promises to pay the investor a set rate of interest over a specified period, typically semi-annually or annually. At the bond's maturity date, the issuer repays the principal amount to the investor.
For example, if an investor buys a $1,000 bond with a 5% annual interest rate and a 10-year maturity, they will receive $50 per year and the original $1,000 at the end of 10 years.
Bonds come in various forms, each with distinct characteristics:
| Type | Description | Example |
|---|---|---|
| Government Bonds | Issued by national governments to fund public projects and operations | U.S. Treasury bonds |
| Corporate Bonds | Issued by companies to finance business expansions or other initiatives | Apple Inc. corporate bonds |
| Municipal Bonds | Issued by local governments or municipalities for community projects | City of Chicago municipal bonds |
| High-Yield Bonds | Issued by entities with lower credit ratings, offering higher interest rates to compensate for the increased risk | Junk bonds from a startup company |
Investors purchase bonds for several reasons:
According to the U.S. Securities and Exchange Commission, bonds are generally considered safer investments than stocks because they have a lower risk of default. However, the safety of a bond depends on the issuer's creditworthiness.
Many people confuse bonds with stocks. While both are financial instruments traded on exchanges, they serve different purposes. Bonds represent a loan, whereas stocks represent ownership in a company.
Another misconception is that bonds are always safe. High-yield bonds, often called "junk bonds," carry a higher risk of default. Investors must assess the credit rating of the bond issuer before purchasing.
The yield of a bond is the return an investor earns from the bond's interest payments and any capital gains or losses from changes in the bond's price. Bond prices and yields move inversely: as bond prices rise, yields fall, and vice versa.
For instance, if interest rates rise, newly issued bonds will offer higher yields, making existing bonds with lower yields less attractive. This causes the price of existing bonds to fall.