Bonds

Companies need capital to operate. They may take out loans to generate that capital, but that makes them liable to pay that money back to the bank with interest. Issuing bonds is a way for a company to generate capital that works like a loan but on the company’s terms.

How Bonds Work

Bonds are issued for a given amount—say $1,000.00—to be redeemed on a given date (which is referred to as the bond’s date of maturity). You purchase the bond for the face value of $1,000.00 and probably a premium on top of that, perhaps $100.00, for a total of $1,100.00 paid. Depending on market conditions, you may end up paying less than face value for a given bond; it mostly depends on how prevailing interest rates compare to the bond’s interest rate.

Between the point of purchase and the bond’s date of maturity, the issuer of the bond will regularly pay you an amount of interest determined by the interest rate associated with the bond. This is generally a fixed rate assigned to the bond when it’s issued, but some bonds have variable rates. When the bond matures, you may redeem it with the issuer for its face value. The bond’s return on investment is determined by its face value and interest paid minus the price you originally paid.

Risks

Bonds are backed only by the company that issued them, which may or may not be insured against bankruptcy. If the company starts to fail, there’s no guarantee that the bond will be honored when it matures, but bondholders must be paid off before stockholders.

When interest rates fall below the rates set on the bonds a company has issued, the company may recall the bonds, offering to redeem them for payouts higher than the face value.

For investors wary of taking risks, even the Federal government issues bonds. United States Treasury bonds are noted for their safety.

Liquidity of Bonds

Many bonds can actually be redeemed before their date of maturity, usually at less than face value but sometimes at par. There’s no real trading of bonds in United States markets, though, because they are issued to individuals and can only be redeemed by that individual. Bearer bonds, bonds redeemable by whoever is carrying them, are extremely liquid…and illegal in the United States since the early 1980s.