A bond is a loan to a company.  The company will pay the bondholder a set interest rate for the duration of the bond.  The interest rate that the bondholder is a little more complicated than looking at the interest rate of the bond.  For example, lets assume that a $1,000 bond is paying 10%.  This means that every year the bond will pay $100.  However, when the bondholder purchases the bond she could pay $900.  This would make the interest rate received 11.11% (=100/900).  Or, the bondholder pays $1,100.  In this case the interest rate received would be 9.09% (=100/1100).

If something happens to the company, the bondholders will be paid before the shareholders (owners of stock).  In other words, the dividends will be cut prior to the interest payments. 

 

Interest payments can occur monthly, quarterly, annually or, in the case of “zero coupon” bonds, the principal and interest will be paid once at the date of maturity.  The interest of Federal Bonds should be federally tax free and possibly state tax free.  Municipal Bonds interest should be tax free in the state they are issued.  The tax status of a bond will also affect the “after tax” return, so comparisons should be made on the “after tax” return vs. risk of each bond to determine the best bond for each investor.

 

 

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