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Bond

A bond is an interest bearing or discounted debt security issued by corporations and governments. Bonds are essentially loans by the investor to the issuer in return for interest payments.

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Expanded Definition

Bonds may either be corporate bonds or government bonds. Bonds are rated by bond rating agencies, especially by Standard and Poor's, Moody's, and Fitch. Bonds are classified by their bond rating and their maturity. Interest rates are determined by market conditions, but typically bonds are traded at a differential from the yield curve.

Bonds are bought and sold by bond traders or by the bond desk of your broker. Although some bonds are listed on major exchanges, most are traded over the counter. Most individual investors find it necessary to hold bonds to maturity as the resale market is limited. Bonds can be sold but usually at the price offered by the bond desk of your broker. The bid ask spread is said to be wide.

The interest rate paid by a bond at its face value is called its coupon. A bond is a contract to pay a fixed amount of interest, i.e., the coupon, on specified dates for a specified period, and then to return the face value to the bondholder on a specified date, i.e., the maturity date. In days gone by, bonds were issued with coupons attached. On the payment date, the bondholder mailed in the next coupon to receive his interest payment. In modern times, interest is paid to the registered owner of the bond on the due date, but the traditional language remains.

Asset backed securities or trust preferred issues are a new class of bonds. They are listed and traded on major stock exchanges as preferred stocks. Each issue is backed by a single corporate bond. Hence, these are in effect corporate bonds traded on major stock exchanges and available at discount broker commissions.

Many bonds are callable. The issuer may call the bond at a specified price on or after a specified date. The details are listed in the prospectus for the issue. QuantumOnline [1] does an excellent job of summarizing call provisions. It also provides links to the original prospectus for the issue. (But the bond ratings shown are when issued and may not be current.)

Those considering purchase of a bond should research call provisions. Bond yields are often supported by the call price. Paying a premium over the call price can result in having the bond called out from under you at a loss. Hence, bonds near or after their call date often have their market value held down by the call price. That can cause them to show up in bond listings as remarkably high yielding bonds. Be especially careful of bonds paying above market yields.

A common investing strategy used by bond investors is the laddered maturity bond portfolio or bond ladder. Bonds are selected to mature at regular intervals for a specified maturity. As the shortest bond matures, it is replaced with a new bond of the longest maturity. A ladder provides steady income from interest payments and is little affected by changes in interest rates.

TMFPhila has conducted a Foolish Bond Seminar on his blog. [2]

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