What Are Bonds?
Bonds are an investment product where you agree to lend your money to a government or company at an agreed interest rate for a certain amount of time. In return, the government or company agrees to pay you interest for a certain amount of time in addition to the original face value of the bond.
Bonds have a face value, which is the amount you will get back at when the bond comes due and a coupon amount, which is the interest paid each year.
How Bond Prices Work
In most cases, a bond's interest rate is set when it's issued, and the rate won't change. However, the secondary market price of a bond can rise or fall depending on current interest rates.
Let's say you bought a 10-year bond yesterday with an interest rate of 5% per year. If market interest rates halved overnight to 2.5% per year, then the income from your bond would be twice as valuable. This would increase the price of the bond.
If interest rates had doubled to 10%, the income from the bond would be only half as valuable. This would decrease the price of the bond.
The most common way to buy bonds is either through a broker, mutual fund, exchange traded fund, or directly from a government.
- Through A Broker
You can buy bonds through a broker, just like you can buy stocks and other investments. The bonds you buy are typically sold by investors. Depending on the interest rate market, you may be able to buy the bond at discount.
- Through the Government
You can buy government bonds directly through the federal government. The Treasury Direct website allows you to buy government bonds.
There are organizations that rate the quality of each bond by assigning a credit rating.
- Low Bond Rating
If the bond rating is low, or "below investment grade", the bond may a high yield but it will also have a risk leveel.
- High Bond Rating
If the bond is rating is high, the bond yield may be lower but it is deemed safer.
The two best-known agencies that rate bonds are Standard & Poor's (S&P) and Moody's Investors Service.