This is my Bonds 101 blog designed to give you some basics on what a bond is. I only feature three different types as not to confuse you (or me for that matter). After you read this blog you’ll be able to walk into that cocktail party ready to flex some intellectual muscle. Oh yes, you will be armed and dangerous! Let’s get started and break a mental sweat before you put that mind back on holiday.
What is a bond?
A standard bond specifies the fixed amounts to be paid and the exact dates of the payments. How much should you be willing to pay for a bond? The answer deprends on the bond’s characteristics. We will look at three basic types.
Zero-coupon bonds: These are bonds which promise a single future payment, such as a U.S. Treasury bill. These are very common. Basically this is when you buy a bond for a set price, say $70 present value and the bond will pay the full note amount, say $100 in 5 years depending on the interest rate.
Coupon bonds: These are bonds which make periodic interest payments and repay the principle at maturity (a fixed time period is specified). Coupon bonds do not have an individuals name on it (essentially they are unregistered). Whoever is in physical possession of the coupon bond itself can collect the money. Coupons are affixed to the bond itself. The holder / owner of the bond will send in one of the coupons at a set time and receive an interest payment for the bond. U.S. Treasury bonds and most corporate bonds are coupon bonds.
Consols: These are bonds which make periodic interest payments forever; never repaying the principle that was borrowed. Because governments are really the only borrowers that can credibly promise to make payments forever, there are no private consols. So let’s say you by a consols bond for $500. You will never get a direct payoff, but you will be ensured interest payments until the day you die.
So there you have it. We’ve covered three different bond types to wet your pallet. I tried to keep it pretty basic. Converting the return on your investment by looking at yield to maturity is another blog for another time. But for now I hope this helps. Now go rush out and get a “Fond for Bond” bumper sticker!
