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While a share of stock represents partial ownership (equity) in
a company, bonds represent debt payable by a company to the
bondholders. Interest on bonds must be paid in good times or
bad, like any other debts, which may be an attractive feature
for investors seeking greater capital security and assured
income.
A company issuing a bond agrees to repay the amount borrowed
plus a specific rate of interest at an agreed time, the maturity
date. On the face of a bond certificate is the name of the
company issuing the bond, the serial number, the principal
amount of the bond, the rate of interest, and the maturity date.
The quality of a bond usually can be determined by its rating.
Ask your broker for the rating of a particular bond you are
interested in.
If the issuer is creditworthy, bondholders can expect regular
interest payments on specific dates. As with any investment,
there is a risk that you may lose all or part of your investment
should the company issuing the bonds go bankrupt. However,
bondholders’ claims in a bankruptcy must be satisfied before any
payments are made to preferred or common stockholders.
A common area of misunderstanding for those who invest in bonds
is the inverse relationship between interest rates and bond
prices by which an increase in interest leads to a decline in
bond prices. When interest rates are higher than current yields
on bonds, demand tends to shift away from the bond market and
into the bank market.
Bondholders then sell their bonds to take advantage of the more
favorable interest rates, creating a downward pressure on bond
prices.
Bonds are issued by federal, state, and local governments, and
by business corporations. U.S. government bonds are considered
the safest, since the U.S. government has the highest credit
rating of any borrower. State and local governments offer what
are commonly referred to as “municipal bonds,” which have the
advantage of a federal tax exemption on interest paid.
Corporate Bonds Corporate bond issues vary widely, but a few of
the more common corporate bonds include the following:
Sinking fund bonds Some bonds are backed by a “sinking fund” for
which the issuer is required each year to set aside a certain
amount of money to retire the securities when they mature.
Mortgage Bonds Bonds in which a corporation pledges certain
assets (real estate) as collateral to secure the bond payment.
Debentures These bonds are not secured with collateral or
specific property, but are backed by a corporation’s general
credit. Debentures are not necessarily less creditworthy than
mortgage bonds, and, in fact, some have top credit ratings.
Junk bonds These are high-yield, high-risk bonds of two types:
those which are investment-grade when originally issued, but
which have subsequently been downgraded, and those originally
issued as low-grade bonds. The latter group includes bonds
issued by low-rated companies to finance operations, as well as
those issued in connection with corporate takeovers.
Convertible bonds A convertible bond gives its owner the
privilege of exchange for other securities of the issuing
company at some future date and under prescribed conditions.
Zero-coupon bonds Zero-coupon bonds make no periodic interest
payments, but instead are sold at a deep discount from face
value. The buyer of such bond receives the rate of return by the
gradual appreciation of the bond, which redeems at face value on
a specified maturity date.
About the author:
Larry Westfall is the owner of DIY Investing -
http://www.pennystockebook.com
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