Introduction to Bonds (Part 1)

Introduction

What is a bond? You may have heard this term before, especially when paired with stocks. They are one of the most popular investment options out there. A bond is a loan issued by a group, usually a government or

a company. When you buy a bond, you lend the bond issuer a certain amount of money, and they will pay it back to you over time, with interest. Interest is additional money that you can earn from lending money, and is usually in a percentage. Another example where you may see interest is when you put money into a bank account. When you do this, you are basically lending money to the bank. In return, the bank will regularly give you a small amount of money, usually every month. If you’ve ever taken out a loan, you’ve also seen interest at work, since the amount you end up paying the lender is more than the amount you borrowed.

The Key to Bonds

The power in bonds lies in what I just talked about: Interest. When you earn interest from a bond, it is compounded. What this means is that you are earning interest upon the interest you already earned.

As a simple example, let’s say you buy a bond for $100 with a 10% annual interest rate. This means that the money your bond is worth increases by 10% each year. The next year, you gain 10% of $100 in interest, or $10. This brings the total value of the bond to $110. Next year, you gain another 10% interest. However, this time the 10% is applied to the $110 instead of the original $100. So now you earn 10% of $110, which is $11. The past year, you only earned $10 in interest, so after only one year, you’ve already earned an extra dollar than you did previously.

A lot of bonds are going to be bought at more than $100, and, while a 10% interest rate is rare, the bond can be held for a long time, which gives a lot of time for the interest to build up. At the end of the period, you are going to get back a lot more money than what you paid for to buy the bond. That’s why bonds can be so powerful.

Parts of a Bond

There are three main parts of a bond. The first is the par value. This is the amount that you purchase the bond at. Most often, it will be $100 or $1,000. The next is the interest rate. This is the amount of interest that you will get, and is expressed in a percentage. The last part is the maturity date. This is the amount of time that you will have to wait before you get paid back for your bond.