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By Larry Westfall
While a share of stock represents partial ownership (equity) in a company,
bonds represent debt payable by a company to the bondholders. Interest on
bonds must be paid in good times or bad, like any other debts, which may be
an attractive feature for investors seeking greater capital security and
assured income.
A company issuing a bond agrees to repay the amount borrowed plus a specific
rate of interest at an agreed time, the maturity date. On the face of a bond
certificate is the name of the company issuing the bond, the serial number,
the principal amount of the bond, the rate of interest, and the maturity date.
The quality of a bond usually can be determined by its rating. Ask your broker
for the rating of a particular bond you are interested in.
If the issuer is creditworthy, bondholders can expect regular interest
payments on specific dates. As with any investment, there is a risk that you
may lose all or part of your investment should the company issuing the bonds
go bankrupt. However, bondholders’ claims in a bankruptcy must be satisfied
before any payments are made to preferred or common stockholders.
A common area of misunderstanding for those who invest in bonds is the inverse
relationship between interest rates and bond prices by which an increase in
interest leads to a decline in bond prices. When interest rates are higher
than current yields on bonds, demand tends to shift away from the bond market
and into the bank market.
Bondholders then sell their bonds to take advantage of the more favorable
interest rates, creating a downward pressure on bond prices.
are issued by federal, state, and local governments, and by business
corporations. U.S. government bonds are considered the safest, since the U.S.
government has the highest credit rating of any borrower. State and local
governments offer what are commonly referred to as “municipal bonds,” which
have the advantage of a federal tax exemption on interest paid.
Corporate
Corporate bond issues vary widely, but a few of the more common corporate
bonds include the following:
Sinking fund bonds
Some bonds are backed by a “sinking fund” for which the issuer is required
each year to set aside a certain amount of money to retire the securities
when they mature.
Mortgage
in which a corporation pledges certain assets (real estate) as collateral to
secure the bond payment.
Debentures
These bonds are not secured with collateral or specific property, but are
backed by a corporation’s general credit. Debentures are not necessarily less
creditworthy than mortgage bonds, and, in fact, some have top credit ratings.
Junk bonds
These are high-yield, high-risk bonds of two types: those which are investment-
grade when originally issued, but which have subsequently been downgraded,
and those originally issued as low-grade bonds. The latter group includes
bonds issued by low-rated companies to finance operations, as well as those
issued in connection with corporate takeovers.
Convertible bonds
A convertible bond gives its owner the privilege of exchange for other
securities of the issuing company at some future date and under prescribed
conditions.
Zero-coupon bonds
Zero-coupon bonds make no periodic interest payments, but instead are sold at
a deep discount from face value. The buyer of such bond receives the rate of
return by the gradual appreciation of the bond, which redeems at face value
on a specified maturity date.
Larry Westfall is the owner of DIY Investing - http://www.pennystockebook.
com
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