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Investments Bond Basics

Though there are numerous different ways that you can invest your money in bonds, it is initially essential to first understand all your bonds investment options, which vary between purchasing simple individual bonds to selecting unit investment trusts and bond funds.

What are Bonds?

A bond in financial terms is an instrument of indebtedness of a bond issuer to the holder. It is a debt security wherein an issuer owes bondholders a debt and is obligated to pay them interest and/or repay the principal amount at a later date, referred to as maturity. In simple language, a bond is a form of loan in which the bondholder is the creditor (lender), the issuer of the bond is the debtor (borrower), and the interest paid is called a coupon.

Bondholders do not hold a share in the company's profits. Instead, they receive fixed returns on their investments. This return, stated as interest rate or coupon rate is only a percentage of the original offering price of the bond. The name coupon came into existence because paper bond certificates issued in the past had coupons attached to them. On the due date, the holder would hand in the coupon to the bank, in exchange for the interest payment.

Bondholders do not hold a share in the company's profits. Instead, they receive fixed returns on their investments. This return, stated as interest rate or coupon rate is only a percentage of the original offering price of the bond. The name coupon came into existence because paper bond certificates issued in the past had coupons attached to them. On the due date, the holder would hand in the coupon to the bank, in exchange for the interest payment.

Generally, the interest rate is fixed throughout the term of the bond, but could vary according to the money market index. Interest is generally payable at a fixed interval, which can be annual, semiannual or monthly. Quite often, a bond is negotiable and the ownership of the instrument is transferrable to the secondary market.

The bond issuer has to repay a nominal amount of money on the maturity date. The issuer has no obligations to the holders after maturity date, as long as all the due payments have been made. The period of time until the date of maturity is referred to as term, tenor or maturity.

There are 3 categories of bond maturities.

1. Short Term: These include maturities between 1-5 years.

2. Medium Term: These include maturities between 6-12 years.

3. Long Term: These include maturities of more than 12 years.

Investing in Bonds:

Bonds are mostly traded by institutions such as banks, insurance companies, pension funds, sovereign wealth funds and hedge funds. Pension funds and insurance companies have liabilities that mainly include fixed amounts that are payable on predetermined dates. Most individuals who want to buy bonds do so through bond funds.

Investing in Bonds:

Bonds are mostly traded by institutions such as banks, insurance companies, pension funds, sovereign wealth funds and hedge funds. Pension funds and insurance companies have liabilities that mainly include fixed amounts that are payable on predetermined dates. Most individuals who want to buy bonds do so through bond funds.

Types of Bonds:

There are several types of bonds available in the market. Some of them include:

1. Fixed Rate Bonds: Coupon remains constant throughout the bond term.

2. Floating Rate Notes: These have a variable coupon rate that is linked to a reference rate of interest.

3. Convertible Bonds: These allow the holder to exchange a bond for a number of shares from the issuer’s common stock.

4. Exchangeable Bonds: These allow exchange for shares of a corporation besides the issuer.

5. Inflation Linked Bonds: In this the principal amount and interest is indexed to inflation. The interest rate is usually lower than fixed rate bonds, but payments increase with inflation as the principal amount grows.

5. Inflation Linked Bonds: In this the principal amount and interest is indexed to inflation. The interest rate is usually lower than fixed rate bonds, but payments increase with inflation as the principal amount grows.

6. Covered Bonds: These are backed by the cash flow from public sector assets or mortgages.

7. Asset-Backed Securities: These are bonds whose principal payments and interest are backed by cash flows from other assets.

Spreading your investments across various bonds and stocks is the ideal investment choice for many. However, choosing the right bonds can be a confusing decision for many. It is best to consult a professional and experienced investment agent for advice on investing in bonds.

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