Bill Poulos describes what bonds are, why bonds are purchased, the value of bonds, and trading bonds. Read this article for more information from Bill Poulos on bonds.
A bond issue is a large loan that is put together by a government or corporation in order to raise money for the organization. The money could be used for general purposes or it could be earmarked for something like a specific project, a large purchase or a large expenditure of some type. Each individual bond that is sold is a small piece of the total bond issue.
The reason that someone would purchase a bond, a bondholder, is because there is a stated amount of interest that will be paid to the bondholder which is typically paid on a monthly basis. Each bond and bond issue has a finite life, at the end date of the life of a bond, the maturity date; the bondholder will receive his principal investment back which is the original purchase price of the bond or the amount that was originally loaned when the bond was first purchased. Since bonds pay a stated amount of interest the higher the interest rate is the more in demand the given bond may be.
There are many factors that determine the desirability of a bond which include but are not limited to; the credit worthiness of the issuer, the purpose for the bond issue itself and the interest rate. Like any interest bearing investment there is an opportunity cost to buying a bond because you are tying up a specific amount of money for a specified period of time. The opportunity cost of owning and holding a bond is the difference between what can be done with that money versus what the bond produces. There are allot of ways to make money and there are allot of places to invest it so foregoing another potentially higher returning investment to purchase a bond is something that should garner serious thought.
One of the main reasons to purchase a bond is to receive the regular income so depending upon where a person is in their investing life owning some bonds in a portfolio may be a very wise choice. The decision to buy a bond in large part may come down to the issuing organizations ability to repay the loan, the safer the bond is considered to be the lower the interest rate will likely be but given the right set of circumstances even owning a bond with a lower interest rate may make allot of sense.
It is somewhat rare for a bondholder to hold a bond until it matures unless it is a relatively short term issue. There is a secondary market for most bonds so they can easily be bought and sold. The value of a bond will increase and decrease which is based in part by the prevailing market interest rate and any changes to the current market interest rate. If a bond is issued and interest rates rise the lower interest producing bond may not be that desirable, but conversely, if interest rates fall the same bond could look allot more attractive.
There are many factors that determine the value of a bond on the secondary market and the intent of allot of bondholders is to purchase a bond holding it for a period of time collecting the interest and then selling it in the future as its value rises. Trading bonds is often times associated with more volatile or more risky bonds but almost any bond can be freely traded as long as there is a market for it.