Do you want to improve your portfolio's risk-return profile? Bonds can help to balance out a portfolio by diversifying it and reducing volatility. However, even experienced investors may find the bond market strange.
Many investors make just passing investments in bonds because they are perplexed by the seeming complexity of the bond market and language. In reality, bonds are quite simple debt instruments. So, how do you enter this market? How do bonds work? Learning these essential bond market phrases can help you get started with bond investing.
How do bonds work? A bond is essentially a loan taken out by a business. Instead of going to a bank, the company receives funding from investors who purchase its bonds. In exchange for the capital, the corporation provides an interest coupon, which is the annual interest rate paid on a bond stated as a percentage of its face value.
The corporation pays the interest at predetermined periods (typically annually or semiannually) and returns the principal on the maturity date, which marks the end of the loan.Bonds, unlike stocks, can vary greatly depending on the provisions of its indenture, which is a legal instrument that outlines the bond's features. Because every bond issue is unique, it is critical to understand the specific terms before investing.
There are six key characteristics to look for when considering a bond.Types of Bonds Corporate Bonds Corporate bonds are debt securities that firms issue to cover their expenses and raise money. The yield on these bonds is determined by the creditworthiness of the issuer. The riskiest bonds are known as "junk bonds," yet they also provide the greatest yields.
Corporate bond interest is subject to federal and local income taxes.Sovereign Bonds National governments issue sovereign bonds, often known as sovereign debt, to cover their expenses. Because the issuing governments are extremely unlikely to default, these bonds often have a high credit rating and a low yield. Treasuries are the term used in the United States for federal government bonds, whereas gilts are used in the United Kingdom.
Treasuries are immune from state and local taxes, but they are still subject to federal income taxes.Municipal Bonds Municipal bonds (munis) are bonds issued by local governments.
Contrary to what the name implies, this might include state and county debt as well as municipal debt. Municipal bond income is not taxed in most cases, making it an appealing investment for investors in higher tax bands.
Source: Investopedia.com