How do bonds work

1.08K views

i know this is a broad topic so some leading questions would be
how is price determined
what is maturity
what are different types of bonds
how does the government use the money
Analogies make explanations a lot easier, for I am not smart.

In: Economics

3 Answers

Anonymous 0 Comments

A bond is an agreement offered by an institution (typically banks, companies, or governments) that they will give you money in the future on a schedule if you buy it now.

If Ford wants 1Million dollars today, they could sell 1.1 Million worth of bonds due in a year. You give them 1 Million today and they’ll give you 1.1 Million next year. These are open to investors so whoever will pay the most for the bond will receive it, thus there is a bond market and an interest rate associated.

Bonds can be traded between people before they are due. Bonds can also pay smaller amounts before the final lump sum called coupons.

Bonds are safer than stocks and are treated like loans. If the company goes bankrupt, they will liquidate their assets (sell everything) and use that money to pay back their loans and bondholders first.

Anonymous 0 Comments

A bond is just a nation, bank, company, or whomever asking the open market for loans. They agree to pay you back at a sent time, with a set rate of interest.

So a 1-year $10,000 bond at 1% means you give them $10,000. Then, a year later, they give you $10,100. Plus or minus some depending on the terms and details of the loan.

“Maturity” is how long until the loan is over.

The price, which is really just the rate, goes up and down depending on how many people buy the bonds and how much the nation, bank, company needs the loan. If they REALLY need the loan, the price goes up. If everyone is clambering to buy bonds (like in a crashing market), the price goes down.

There ARE different types of bonds…. but I’m not that smart. But they’re really just loans.

(And the FED buying bonds is a little different, because they literally never run out of money. When the US FED, the central bank, buy bonds they’re summoning money from nowhere. Colloquially called “printing money”. It devalues all the other money in the system. Buuuuut they only do this when everything crashes and becomes worthless. So the worthless stocks are now the same price as the worthless money. Wheee stability)

Anonymous 0 Comments

Some key terms highlighted:

A bond is a common type of debt security. **Security** just means it is fungible, can be traded between people, and has some sort of financial value. With the exception of extremely short-term debt, most bonds pay some sort of **interest** rate. This is also sometimes called a **coupon** rate and the payment of the interest is sometimes called the coupon payment. This is because older bonds were bearer bonds, meaning there was no record of who owned them and you needed the physical bond itself to be paid. They literally had coupons attached to them that you could clip off and redeem for payment.

Bonds will usually pay interest twice per year until the date they **mature**, when the last interest payment is made plus the **face amount** of the bond (the loan is repaid). The face amount of most types of bonds is always the same: $1,000. This is also sometimes called the **par value**.

An important thing to realize is that the face amount and the interest payment of any given bond do not change over time. (With rare exceptions.) However **bond yields** do change over time. How is this possible? Because the price of the bond changes over time. If I buy a 5-year bond when it is first auctioned, I will usually pay around par value–$1,000. However let’s say a year from now the borrower gets sued and their credit rating drops, or perhaps interest rates in general are just higher. If I try to sell that bond to another investor, I am not going to get $1,000 anymore because it doesn’t pay enough interest. Instead I may only get $950 when I sell it. Since the person purchasing the bond only had to pay $950, the bond yield has increased. They will receive the same coupon payment and $1,000 payment at maturity, despite investing less, so obviously the overall return has increased. When a bond sells below its par value of $1,000, this is called selling at a **discount**. When it sells above its par value, it’s selling at a **premium**.

Bonds can have all kinds of maturities, anywhere from months to decades. And there are also lots of special exceptions to everything I just wrote. For example, “**stripped bonds**” are bonds (or derivatives of bonds) where an intermediary will “strip off” the coupon payments and sell them to one investor and then sell the face amount payment to another investor. And even though most bonds have a set coupon payment and par value, there are exceptions there as well; notably “**I Bonds**” and “**TIPS**,” (Treasury Inflation Protected Securities), which are two different types of US Government debt that adjust their return based on the consumer price index, in order to protect the buyer from rising inflation rates.