A bond is a type of financial investment with a fixed interest yield. Many investors practice bond investments to diversify their portfolios, especially with long-term goals in mind. But before getting into a bond investment, you must need to have an explicit understanding of how it works.
When you buy a bond, you lend your money to an issuer – corporate entity or government – and in return, the issuer would pay you a fixed agreed-upon interest for the number of years the bond is expected to last, and when the bond “matures,” you’d get back the principal. This article explains bonds meaning in finance.
What Actually is a Bond Investment | Bond Meaning in Finance?
Put simply, a bond is a “debt security” that looks to favor most modern-day investors. It is a low-risk, potentially high-yielding investment. Stocks and bonds have pretty much similarities – they are securities.
In finance, a bond is a type of security under which an issuer (the debtor) owes the holder (the creditor) a debt and is obliged – based on agreed terms – to repay the borrowed debt (principal) at a decided date (maturity date) with interest (coupon). But unlike the principal, the interest of bonds is paid at specific intervals: quarterly, semiannual, annual, or any other agreed intervals between the creditor and the debtor.
Usually, people who do bond investments are high-profile investors, and the issuers (debtors) are often corporate or government entities. Practically, a bond is a type of loan. Bonds are classified into many sections: government bonds, corporate bonds, municipal bonds, and other classifications. Among the reasons why many big-name investors do bond is the low-risk nature.
In organizational hierarchy, when a buy a company’s stock, you become one of the owners, but bond investors (bondholders) have a creditor stake in the company or government body they borrowed money to, – they are lenders – and as such they have command higher priority than stockholders – this is practical difference different stock investments and bond investments.
Many noteworthy investors use bonds to create a more balanced portfolio while also diversifying their investments.
Features of Bond Investing
These are terms used in bond investments; if you must invest in bonds, it is important that you know these terms and understand what each of them means.
- Principal: Also called nominal, face amount, or par, the principal is the actual amount given to the borrower by the issuer/creditor to be repaid at the end of an agreed timeframe.
- Maturity: This is the length of time agreed by the issuer and borrower in which the principal (actual amount being borrowed) will be repaid.
- Coupon: This is the interest – based on the principal amount – the issuer pays to the holder. Coupons can be paid quarterly, annually, or within any specific timeframe.
- Yield: Bond yields refer to the “profit” an investor will make from investing in the bond.
- Credit Quality: This is the measure of the possibility of an issuer (borrower) to repay the bondholder(s) at due dates. This measure is based on many factors.
- Market Price: The volatile market price of a tradable bond.
- Indentures: Not mentioned commonly in bond investing discussions, but this refers to a “formal debt agreement” that influences the terms of a bond issue.
- Covenant: Clauses of such a bind agreement – specifying the duties and actions of parties involved in the business.
