Bond market Meaning
Back in the old days, investors owned actual paper copies of corporate bonds. Photo: Stockbyte/Getty Images
Definition: Bonds are loans made to large organizations. These include corporations, cities and national governments. A bond is a piece of a massive loan. That’s because the size of these entities requires them to borrow money from more than one source.
The borrowing organization promises to pay the bond back at an agreed-upon date. Until then, the borrower makes agreed-upon interest payments to the bondholder.
In the old days, when people held paper bonds, they would redeem the interest payments by clipping coupons. Today, this is all done electronically.
Bonds pay off in two ways. First, you receive income through interest payments. Second, you can receive payment if you resell the bond. Of course, if you hold the bond to maturity, you will get all your principal back. That's what makes bonds so safe. You can't lose your investment unless the entity defaults.
That would be especially attractive if it was highly unlikely that the company issuing the bond would default on its debt.
In that case, you might do well to sell the bond, pocketing the profit. In most of these cases, the company issuing the bond would recall it. The firm would reissue debt at lower interest rates.
Like stocks, bonds can be packaged into a bond mutual fund. That's a good way for an individual investor to let an experienced mutual fund manager pick the best selection of bonds. A bond fund can also reduce risk through diversification. This way, if one entity defaults on its bonds, then only a small part of the investment is lost.
Over the long haul, bonds pay out a lower return on your investment than stocks. In that case, you might not earn enough to outpace inflation. Investing only in bonds might not enable you to save enough for retirement.
Companies can default on bonds. That's why you need to check the bondholder’s S&P ratings. Bonds and corporations rated BB and worse are speculative. That means they could very easily default. They must offer a much higher interest rate to attract buyers. The highest paying and highest risk ones are called junk bonds.
For many people, valuing bonds can be confusing. That's because bond yields move inversely with bond values. In other words, the more demand there is for bonds, the lower the yield. That seems counter-intuitive. Why would investors want bonds if the yields are falling? Because bonds seem safer than stocks.
What Bonds Tell You About the Economy
Since bonds return a fixed interest payment, they tend to look more attractive when the economy and stock market decline.
When the stock market is doing well, investors are less interested in purchasing bonds, so their value drops. Borrowers must promise higher interest payments to attract bond purchasers. That makes them counter-cyclical. When the economy is expanding or at its peak, bonds are left behind in the dust.
The average individual investor should not try to time the market. You should never sell all your bonds, even when the market is at its peak. That's when you should add bonds to your portfolio. That will provide a cushion for the next downturn. A diversified portfolio of bonds, stocks and hard assets gets you the highest return with the least risk. Hard assets include gold, real estate and cash.
When the economy contracts, investors will buy bonds and be willing to accept lower yields just to keep their money safe.
Those who issue bonds can afford to pay lower interest rates and still sell all the bonds they need. The secondary market will bid up the price of bonds beyond their face values. That means the interest payment is now a lower percentage of the initial price paid. The result? A lower return on the investment, hence a lower yield.customer success manager interview questions lipedema weight loss success what is the success rate of proton therapy lung transplant success rate iud success rate client success manager salary success nutrition facts northwell health lake success follicle size for iui success iui success rate la fitness lake success success academy harlem connect for success video success overnight success slap tear surgery success rate what does success mean to you african american quotes about success kidney transplant success rates probability of success calculator cone biopsy success rate songs about success retinal tear laser surgery success rate success is when preparation meets opportunity winston churchill success quote midwives brew success rate way of the wolf: straight line selling: master the art of persuasion, influence, and success path to success how do you say success in spanish success boil in bag rice success rate by age probability of success what led to henry ford's success as an entrepreneur before we can evaluate the success of a drug treatment program, we have to understand the program's car t cell therapy success rate what is the success rate of urolift bible verses for success success memes success good morning quotes success kid memes conjoined triangles of success 1111 marcus ave lake success the success principles ablation for afib success rate what does success mean to you success mortgage partners positive quotes about success success factors login congratulations quotes for success success academy uniform best success quotes iui success stories 2020 belly overhang success stories invitro fertilization success rate success in latin march to success college success foundation team success quotes challenge success entrepeneur success stories national society of leadership and success reddit strategies for success best books for success success verbs femara success first cycle ivf success rates prayer for work success famous quotes about success ovulation pain and pregnancy success stories which of the following is not a key success factor in the country location decision? client success manager lasik success rate success criterias success kid now ivf success tips for success financial success iui success stories