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Asset Class: Debt Bonds. When corporations, cities, counties, states, or the federal government want to raise capital (money) they often borrow it directly from the public. To do this, they issue bonds. Basically, the person who buys the bond (called the bondholder ) is lending money to the corporation or government (called the bond issuer ). Bonds are investment products which are sort of like IOUs — they are evidence of the ownership of a debt. Unlike stock, the investor has no equity (ownership) interest in the issuer. The investor buys the bond and the issuer uses the money for its capital needs. In exchange, the buyer receives receives regular interest payments for a period of time. When the specified bond term ends, which is called the maturity date , the investor gets their money back. In bond- lingo, the interest rate on a bond is called the coupon rate and payments to bond holders are called coupon payments . Many investors buy bonds for the reliable income stream produced by regular coupon payments. For example, if an investor buys a $1000 bond with a coupon rate of 5%, they receive $50 a year in coupon payments. On the maturity date, they get their $1000 back. Bonds and Debentures. Some bonds are secured, meaning the issuer has pledged specific collateral — such as property, equipment, or other assets as security for the bond. This means if the bond issuer is unable to pay back the bond, they surrender those assets to the bondholders who sell the property to recoup their investment. Unsecured bonds are also called debentures . Corporates, Munis, and Treasuries. There are three main types of bonds to invest in. Corporate bonds are issued by companies to raise capital for improvements, expansion of their operations, or any other capital need. Municipal bonds are issued by cities, counties, and states to fund public works , such as a library or roadway improvements. The federal government also “borrows” money from the public by issuing bills, notes, and bonds. Collectively, federal government bonds are called treasuries because they are issued by the U.S. Treasury Department . Treasuries are almost always part of a balanced and diversified portfolio. Bonds are sold on the securities exchange and can be bought by anyone in the world. Reflect on Learning: Anyone, anywhere in the world can buy a bond. A mutual fund in Canada may own municipal bonds issued by a city in California, an investor in Taiwan may own bonds issued to fund the construction of a stadium in Massachusetts, or a Japanese retirement fund may own bonds issued by a corporation in India. Many governments buy bonds issued by other governments. In fact, China holds about $1.25 trillion in American treasuries. Do you understand how bonds are a big part of the global economy? How Bonds Build Wealth. Bonds are complex financial instruments, but a simple explanation is that they’re all about the coupon rate vs. the market interest rate. The value of a bond changes when there is a change in the market interest rate which is the prevailing rate of interest offered on cash deposits. Assume you own a $1000 corporate bond with a coupon rate of 3%. Then, market interest rates fall to 2.5%. Investors are PRODUCT PREVIEW Confederate Zombies! The Confederacy financed much of its Civil War operations by selling bonds. Cotton Bonds were secured by cotton bales. After the war, Cotton Bonds were called Zombie Bonds, because, although they were dead and worthless, they were still traded based on the hope that the U.S. Treasury would eventually pay off the Confederate debt. (It didn't.) Fin Lit Trivia Fin Lit Trivia
Chapter 11 | Investing 101 202
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