Investing 101: What is a bond?

June 10, 4:47 PMBusiness and Finance 101 ExaminerAndy Samuels

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Unlike stocks which are equity securities, bonds are debt securities. What this means is that unlike buying stocks, where you become a partial owner of that company, when you buy a bond, you own nonthing but a piece of that comapany's/government's debt. This makes you a creditor.  Even though bondholders do not share the profits when a company does well, like stockholders do, bondholders come before shareholders if the company were to file for bankruptcy.

While bonds often take a back seat to stocks during bull markets , the merits of bonds are highlighted by bear markets when stocks falter and bonds remain constant. This is because stockholders benefit from a company's success and bondholders do not.

Simply put, a bond is a way for a company/government to borrow money from people. But, people do not lend out their money for free. After a set period of time longer than one year (this is called maturity), the company/government has to pay back the original amount of money they borrowed (this is called the principle) to the bondholder. In addition to having to pay the original money back, companies/governments have to provide an incentive for people to lend them their money. This incentive comes in the form of interest, which is called a coupon.

Bonds can also be traded like stocks. Interestingly enough, a bond can be sold for more or less than its par value (the amount paid out at maturity) based on its risk level, the capital gains, the coupon, etc.

There are several types of bonds. Here are a few of them:

Municipal

A municipal bond is a bond issued by a local government. It is often tax-exepmt.

Governmnet

A government bond like a war bond or Treasury bond is issued by a nation's government. They are viewed as very low risk becuase the chances of the U.S. Treasury, for example, being unable to pay back a Treasury bond is very unlikely.

Corporate

A corporate bond is a bond issued by a corporation. Corporations issue these types of bonds to expand their business in order make even more money in the long run when repaying the bond will not be a problem.

The picture to the top right is of a bond certificate for the state of South Carolina dating back to 1873. It was issued under the state's Consolidation Act.