Bonds are debt investments. They represent a loan you make to an institution—a corporation, government, or government agency—in exchange for interest payments during a specific term plus the repayment of your principal when the bond comes due. Because the income you receive from a bond is generally fixed at the time the bond is created, bonds are often considered fixed-income investments.
Bonds are usually described based on these key characteristics:
- Par value or face value: the amount you’re lending and expect to be paid back, usually $1,000 per bond, but sometimes in multiples of $1,000
- Term: the length of time until the bond matures
- Maturity date: the date on which the principal is to paid in full to you
- Interest: the percentage of the loan amount the borrower will pay you for the use of your money over the term
Making Money with Bonds
You can make money with bonds in two ways:
- Interest. The interest payments from the bond normally provide you with a fixed source of income for the bond’s term. In most cases, the rate is fixed at the time the bond is issued.
- Capital gains. You might also make a profit by selling a bond before maturity at a higher price than you paid for it.
The interest rate is part of the contractual relationship you have with the borrower. It’s determined by a number of factors, including the bond’s term, current market rates, and the creditworthiness of its issuer, which depends on the risk associated with the likelihood of the issuer’s repaying the bond. In general, longer-term bonds pay higher rates to reward you for committing your money for an extended period, but that’s not always the case. It’s also typical for a low-rated issuer to have to offer higher rates to attract interest in its bonds.
