Bonds

Bonds, sometimes called debt instruments or fixed-income securities, are essentially loans. Corporations often raise money by issuing bonds in addition to selling stock. Governments often use bonds to pay for their ongoing operations or specific projects, such as highways or new construction.

The borrower (the bond issuer) typically promises to pay the lender (the bondholder), regular interest payments until a certain date. At that point, the bond is said to have matured. When it reaches its maturity date, the full amount of the loan (the principal or face value) must be repaid to the bondholder. Each bond pays a stated interest rate called the coupon. Most bonds pay interest on a fixed schedule, usually quarterly or semiannually, although some pay all interest at maturity along with the principal. In some cases, the issuer can decide to pay back the loan early by calling the bond and repaying the principal before maturity. The specific terms of a bond are set forth in a bond agreement known as an indenture.

One of the most important reasons why investors choose bonds is for their steady and predictable stream of income through interest payments. Bonds have traditionally been important for retirees for this reason. Also, though they are not risk-free (e.g., a bond issuer could default on a payment or even fail to repay the principal) and individual securities have their own specific risks, bonds as a whole are considered somewhat less risky than stocks. In part, that's because a corporation must pay interest to bondholders before it pays dividends to its shareholders. If it declares bankruptcy or dissolves, bondholders are also first in line to be compensated.

Bond prices may behave very differently from stocks. For example, when stock prices are down, investors often prefer to invest in bonds; this movement is sometimes called a flight to quality because investors prefer the relative stability that bonds and their interest payments offer. Also, when interest rates are high, the return on bonds can be attractive enough that investors become unwilling to assume the greater risk of stocks.

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