Bonds basics

Bonds basics – I’m bond, James “Bond”

I am now in the second post in the series of savings, mutual funds, bonds and CDs and the like, conservative investment instruments. Now I am going to discuss bonds. Here are the basics to bonds:

A bond is very basically a loan and you are the lender. Who's the borrower? Usually, it's either the US government, a state, or a big company like General Motors, if you are lending money to the US government. In Singapore, it is a little known fact that the Singapore government issues bonds too. Many government and business entities need a lot of money to operate - to fund the federal deficit or to build roads and finance factories, for example - so they borrow capital by issuing bonds. Bonds are actually very big business, especially in the United States.

When a bond is issued, the price you pay is known as its "face value." Once you buy the bond, the bond issuer promises to pay you back on a particular day - it's called the "maturity date" - at a predetermined rate of interest - the "coupon." Say, for instance, you buy a bond with a $1,000 face value, a 5% coupon and a 10-year maturity. You would collect interest payments on the bond adding up to $50 in each of those 10 years. When the decade was up, you'd come back to get back your $1,000 and walk away.

A key difference between stocks and bonds is that stocks make no promises about dividends or returns. For instance, General Electric's dividend may be as regular as a heartbeat, but the company is under no obligation to pay it. And while GE stock spends most of its time moving upward, it has been known to spend months or sometimes even years going the other way.

On the other hand, when GE issues a bond, however, the company guarantees to pay back your principal (the face value of the bond) plus interest on the bond. If you buy the bond and hold it to maturity, you know exactly how much you're going to get back, basically. That's why bonds are also known as "fixed-income" investments, as they assure you a steady payout or yearly income. And although they can carry plenty of risk sometimes, as all investments do, this regular income is what makes bonds inherently less volatile than stocks.


As an aside: “Some say that gentlemen prefer blondes; that is incorrect, as it should be: Gentlemen prefer bonds J” (Old joke.)