Analyzing The Best Retirement Plans And Investment Options: Bonds

A bond is an IOU issued by a corporation or government in order to finance projects or activities. When you buy a bond, you are extending a loan to the bond issuer for a particular period of time. In exchange for the loan, the issuer agrees to pay you a specified interest rate (the coupon rate) at regular intervals until the bond matures. In general, the higher the interest rate, the higher the risk for a bond. When the bond matures, the issuer repays the loan and you receive the full face value (or par value) of the bond.

As an example, assume you buy a bond that has a face value of $1,000, a coupon of 5%, and a maturity of 10 years. You will receive a total of $50 of interest each year for the next 10 years ($1,000 * 5%). When the bond matures in 10 years, you will be paid the bond’s face value; or $1,000 in this example.

As an alternative, you could sell the bond to another investor before the bond matures. If interest rates are more favorable now than when you bought the bond, you may take a loss and have to sell at a discount. If interest rates are lower, however, you may be able to sell the bond at a premium (since your higher-interest bond is more attractive). The price for the bond in the previous example (with a face value of $1,000, a 5% coupon, and a 10-year maturity) would decrease if bond rates rose to 6% or increase if bond rates fell to 4%. You would still, however, earn the 5% coupon and receive full face value if you decided to hold onto the bond until it matures

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