Bond Definition: Day Trading Terminology
A bond is a debt investment where investors loan funds to a corporate or government for a particular period of time and at a variable or fixed interest. Companies, governments and municipalities use bonds to raise money with the goal of financing projects.
Also referred to as fixed income securities, it is categorized under one of the three main generic asset classes which include equities and cash. What you need to know is that majority of bonds both corporate and government are traded on public exchanges as well as over-the-counter.
Major Bond Types
In the US, there are four major bond types:
It is one of the largest components of the US bond market. As the largest securities in the world, companies utilize proceeds from corporate bonds for different purposes for example purchasing new equipment, investing in R&D, paying out shareholder’s dividends, refinancing debt and undertaking mergers or acquisitions.
Corporate bonds are classified according to maturity which refers to the time period the company has in order to pay the principal amount to the investors. Maturity can either be:
a. Short term – less than 3 years
b. Medium term – between 4 to 10 years
c. Long term – more than 10 years
Also referred to as munis, these are debt securities issued by cities, counties and states among other governmental entities. They are used to fund day to day obligations as well as capital projects like sewer systems and highways.
Municipal bonds can be purchased in exchange for regular interest payments which are remitted semi annually with the promise of repaying the principal sum. It is important to note that municipal bonds are exempt from federal income tax. Even the interest may be exempt from state and local taxes.
They are issued by the US Department of the Treasury which means they carry the full faith and credit of the federal government. This makes US Treasuries a safe and popular investment. There are several types of US Treasuries and they are:
a. Treasury Bills
As short term securities, they mature within a few days to 52 weeks
They mature within 10 years which means they are long term securities
As another type of long term securities, it has a maturity period of 30 years. Interest is paid after every 6 months.
Investment grade and high yield
Investment grade bonds have a higher credit rating which means they have less credit risk than high yield. High yield are bonds with a lower credit rating thus they have a higher credit risk. As a result, they offer higher interest rates in return.
How Bonds Work
What you ought to know is that bonds provide a way of preserving capital as well as a means to earn returns. Not only that, they do ensure investors have a steady stream of income which is derived from interest before maturity. As said earlier, bonds are exempt from federal, state and local taxes.
A bond is issued to private investors or general public. Interested investors purchase these bonds thus loaning money to the government or corporate. The monies are used to fund different projects such as purchasing equipment or building highways.
Every bond has a defined maturity period which depends on its type. When it matures, regular interest payments are made to the investor.
It is important to understand that bonds do play a crucial role when it comes to an investor’s portfolio. Not only do bonds allow investors to diversify their investments but they are less volatile compared to other securities like stocks. As a safe investment, you are assured of regular payments inform of interest until it matures.