Many people hear the term but really have not the slightest clue about what bonds are or they think of a bond in terms of a prison bond. They know it’s a financial instrument of some sorts but not sure how it plays into the market. The best way to explain what bonds are in layman terms is an IOU or a loan given to a government or corporation. Essentially you are buying the debt that the bond issuer uses for various things such as funding projects in the city for state governments or raise capital for a business in order to sustain their operating costs (example airlines such as American Airlines issued quite a few bonds during the pandemic to stay afloat).
When you a buy a bond at face value you’re buying a debt for a certain amount that pays interest for a certain amount of time until its maturity date. For example if you buy a 10 year bond for a $1,000 at a 5% interest rate, then you will receive $50 ever year until the 10 year mark. Then when it reaches its maturity mark the bond issuer pays you the initial $1,000. Bonds are obligated to be paid back as long as the company does not default. This is why some people prefer government bonds because you are very more likely to be paid back your money since a government defaulting means the end of the government basically.
Currently in this economic market we have seen bonds and stocks fall down in price. The reason being that interest rates and bonds have an inversion relationship so when interest rates are high bond values are down. Remember that interest rates are set by the FED. So when the FED sets the interest rates higher that means bonds that are newly issued will have a higher interest rate. Why pay for a $1000 bond with 5% interest rate when a newer bond for $1000 will have interest rate for 7%, 10%, or 12%?
Therefore many bonds that have been issued long term have lost their value so the prices have gone down in order for them to have the same yield. However, just like with stocks (energy sector), there are a few gems hidden in the bond market. There are currently some bonds that have a 4% yield such as the two-year US Treasury bond or near 10% yield I-bond US Treasury bond. (Yield is the return on your investment.) Did I also mention one of the best things about bonds issues by governments are that they are not subject to taxes meaning the interest is tax free?
