These types of investments are essentially loans to be repaid at a later date. The investor loans some of his money and is repaid an “interest” rate in return. The interest rate is the reason people purchase bonds and is the determining factor when calculating how much an investor will make.
Many investors choose bonds because they are generally deemed a safer investment. Depending on the type of bond purchased investors could be guaranteed a return on their money. Bonds are rated by Moody’s this firm thoroughly analyzes a bond issuers financial capacity to repay their debts plus their interest. Moody’s has a rating range of AAA-CCC with a AAA rating being the best. Bondholders have different rights than stockholders of a company and are entitled to the assets of a company. This means if a company was to go under, all or some of the face value of a bond will be repaid through the sale of company assets. This is one of the reasons bonds are regarded as more secure than stocks.
U.S. treasury bonds are generally regarded as the safest choice an investor can make, that being said they also offer the lowest yield, or interest rate. The federal reserve makes loans through the sale of bonds with maturity dates as short as 3 months and all the way out to 30 years. For the risk averse, these are the bonds of choice. Municipal bonds are also offered, these occur when a city or state needs to raise money. They are also generally considered safe, but they are not as safe as the federal government and should be purchased with more caution. Municipal bonds have defaulted in the past. One of the benefits to purchasing municipal bonds or “munis” is the fact they are tax free. Many times a 4 percent return on a corporate bond is equal to a 3 percent return on a municipal bond. This is certainly something to consider.
Bonds can also be issued through corporations for the purpose of raising money for investments in research or operations. When considering investment in a corporate bond Moody’s evaluation is key. A bond with an “A” rating is considered an investment quality bond, where as one with a “C” rating is likely to be junk. When investing in a “C” level bond it is entirely possible to lose some or all of your investment.
Maturity, Yield, and Face Value
The maturity date for a bond is the date when the bond is to be paid in full to the investor. This date can range anywhere from 3 months to several years into the future. The yield, or annual yield on a bond is the amount of interest paid to the bondholder. This is also a good indicator of the investors profit on the bond. The face value is the amount the bond is worth on it’s date of maturity, most bonds are sold in $1000 increments and the bond holder will be repaid $1000 plus an interest payment on the bonds maturity date.