Investments

Q&A: What is a bond?

A bond is a type of investment that is created when an entity (usually governmental or corporate) wants to borrow money (usually a large sum for a special project) and, in return, offers a fixed payment. The lender receives this fixed payment on a pre-set schedule (usually every 6 months) until the bond matures (or ends), which is when the lender receives their initial investment back. Bonds are most often in $1,000 denominations.

Real-life Application: Government Entity XYZ wants to raise $1,000,000 for a construction project, so they issue 1,000 bonds of $1,000 each offering 5% annual interest. The first payment will be 6 months from when the bonds are issued and the bonds will mature in 10 years. These are the cash flows for an investor of this bond:
Date of issuance: Person A buys 1 of Government Entity XYZ’s bonds for $1,000.
Every 6 months for 5 years: Government XYZ pays Person A $25 (half of 5% of $1,000)
5 years later: Government XYZ pays Person A $1,025 for their last semi-annual payment along with the maturity (or end) of the bond.

So, the investor will have paid $1,000 in order to receive $50 (2 semi-annual payments of $25) per year for 5 years, then at the end of the 5th year, their $1,000 back.

Pro Tip: Bonds tend to have less risk than stocks, but usually also have a lower return.

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