What Is a Bond? (Plus Frequently Asked Questions)

By Indeed Editorial Team

Published 4 July 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

If you're interested in finance or just learning more about various types of investments, learning about bonds may interest you. Bonds are a popular type of security that many private and public investors and entities purchase and sell each day. Learning about these important financial tools may help you develop your knowledge of finance and investments. In this article, we answer the question "What is a bond?", describe the differences between bonds and other types of securities, list some benefits of bonds and answer frequently asked questions about them.

What is a bond?

If you're wondering about the answer to "What is a bond?", It's a debt security that pays periodic interest payments at regular intervals. Bonds are typically a loan between the issuer and the holder. The issuer is required to repay the debt at a future date and pay periodic interest payments until then. A bond's price may fluctuate with changes in interest rates, which may make it more or less valuable depending on prevailing economic conditions. Investors often trade bonds in financial markets. Both companies and the government may issue bonds to raise funds for different purposes.

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Bond vs. other types of securities

Here are the differences between bonds and other types of securities:

Bond vs. loan

A loan is a source of funds that's repaid with interest. Bonds are a type of loan, but many types of loans aren't available as investment opportunities. For example, a bank may provide loans and collect the interest, but not allow others to purchase portions of the loan to receive interest. Investors can easily sell bonds on the open market, providing them with an opportunity to redeem their investment earlier. A lender is usually required to wait until a loan expires before they can redeem their investment.

Bond vs. stock

A stock is a share of ownership in a company that entitles the holder to a share of any profits that the company may make and a proportional amount of any losses of the company. Bonds tend not to reflect any changes in the price of their issuer's stock. A bond's value is usually based upon the market's expectations of a company's ability to repay it, which primarily involves its financial performance.

Stock prices often reflect the growth potential of a company. A company may be profitable but not have much growth potential, so their stock price falls, but because they're still profitable, their bond prices aren't as likely to decrease.

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Bond vs. derivative securities

A derivative security is a security that derives its value from another security, such as a stock or a bond. The underlying security of derivatives is usually an asset, like a stock or a commodity, rather than the credit quality of one's own holdings. The holder of a derivative has no entitlement to the underlying asset. Derivatives are complex securities that may have various factors that affect their price, whereas bonds are more basic in structure, being a loan that you can trade easily.

Bond vs. hybrid securities

A hybrid security is an investment that combines aspects of a bond and stock, or two types of securities, such as a derivative security and a stock. For example, companies may issue convertible bonds that have the features of both a bond and a stock. The investor can choose to convert their bond into stock at a defined price so that the value of the bond may increase with the value of a company.

Benefits of bonds

Here are some potential benefits of investing in bonds:

Reliable source of income from interest

Bonds provide income to investors as they mature. Though the potential earnings from bonds may be lower than other types of securities, they have less risk than stocks or derivative securities dues to their limited fluctuation in returns. The largest risk for bonds is if a company can't repay the original amount when a bond matures. This risk is partially mitigated as bond investors usually have priority to claim money from a company over regular equity investors.

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Reduces risk through diversification

Bonds are a great opportunity to reduce the risk of an investment portfolio. This diversification may reduce risk because the investor may not have all their money in a single industry or sector of the economy. Diversification into bonds is common when investors have other types of investments in securities, such as stocks or futures. Bonds are also less risky and are a more stable source of income, so they can help offset the potential losses from riskier investments in a portfolio.

Provide a hedge against inflation

Bonds help investors protect themselves against rising inflation because they typically pay higher interest rates than the rate of inflation. As inflation grows, bond prices fall and interest rates rise, causing bonds to become more valuable investments in the long term. You can consider this a long-term investment strategy because bonds often have long maturity dates.

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Helps companies raise funds

Bonds help many types of companies generate capital for their business with fewer restrictions. Securing loans from banks often involves lengthy processes and may require certain guarantees from lenders. Governments may issue bonds to raise capital for projects or to provide stimulus to the economy.

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Methods for purchasing bonds

Here are several ways for purchasing bonds as an investment:

Using a broker

Investors may use brokers to help purchase many types of bonds. Brokers can advise on the best bonds to purchase and make the process simpler. They typically charge a commission for this service. They may also help investors hold the bonds and collect interest for them.

Buying an exchange-traded fund

An exchange-traded fund is a company that buys and holds individual bonds from several companies according to a specific set of rules. For example, a technology-focused exchange-traded fund might own many bonds issued by large and midsize technology companies. The value of a fund's shares changes proportionately to changes in the values of those bonds. These funds may be available either on their own or as part of a mutual fund or another investment offering. Buying these funds allows an investor to purchase a stake in several bonds concurrently, which further mitigates risks.

Purchasing directly from the issuer

You can often purchase bonds directly from an issuer. Governments may have a bond programme, allowing the public to invest in a project or initiative. Some companies may release their bonds on an exchange, letting public investors subscribe to them. Larger investors may negotiate directly with a company to purchase bonds in a private transaction.

Frequently asked questions about bonds

Here are answers to some frequently asked questions about bonds:

  • What is a bond maturity date? A bond maturity date is a date when the bond issuer makes the final payment to the investor, which includes their original principal investment. This date is important because the investor won't earn any additional interest payments after this date and it's the date that the purchaser receives their original investment back from the issuer.

  • What is private placement? A private placement is a type of bond that's offered to a small number of investors to keep the offering confidential. The private placement may be exempt from certain securities regulations, making it more efficient for a company to raise funds.

  • Can you lose money with bonds? Companies may perform poorly, resulting in them being unable to pay interest or the original value of a bond. You may also want to sell the bond, but its value has dropped below its principal amount in the open market.

  • What is a callable bond? A callable bond has a specific time period in which the issuer can repurchase the bond under certain pricing conditions.

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