A bond is basically a loan made by a corporation or government with the money used for a specific project such as a plant upgrade or a new bridge. The issuer pays the bondholder a specified amount of interest for a specified time, usually several years, and then repays the bondholder the face amount of the bond.

Bonds may belong in your investment plan for good reasons:

• Economic forces that depress stock prices—the early stages of a recession, for instance—tend to boost bond prices. (The opposite also tends to hold true: When the stock market rises, often due in part to falling interest rates, bond prices often fall.)
• Bonds can generate impressive profits from capital gains.
• Sometimes you can even calculate those gains years in advance on the day you buy the bonds.
• Bonds can provide a predictable stream of relatively high income you can use for living expenses or for funding other parts of your investment plan.
• Some kinds of bonds offer valuable tax advantages and unparalleled opportunities to take advantage of the time value of money, that is, to invest a modest amount with a reasonable prospect of collecting a large amount a few years later.

Note that the word “safety” doesn’t appear in this list. A lot of people think bonds are about the safest investment around, but as you’ll see, such a notion may not always be correct.

What is a bond?
How bonds work
Types of bonds and their relative safety
Why bonds can be an important part of your investment portfolio
Yield and how it relates to bond prices
Bond ratings and how they can help you reduce risk

Download A Primer for Investing in Bonds

PDF format, 283KB, 13Pages.
By the Editors of Kiplinger’s Personal Finance magazine

Contents
1 How Bonds Work
2 Types of Bonds
3 Unlocking the Potential of Bonds
3 The Relationship Between Yield and Price
4 How to Reduce the Risks in Bonds
6 Protect Your Money: How to Check Out a Broker or Adviser
Glossary of Investment Terms You Should Know

About the Investor Protection Trust
The Investor Protection Trust (IPT) is a nonprofit organization devoted to investor education. Over half of all Americans are now invested in the securities markets, making investor education and protection vitally important.

Since 1993 the Investor Protection Trust has worked with the States and at the national level to provide the independent, objective investor education needed by all Americans to make informed investment decisions. The Investor Protection Trust strives to keep all Americans on the right money track.

For additional information on the IPT, visit www.investorprotection.org.

About the Investor Protection Institute
The Investor Protection Insititute (IPI) is a nonprofit organization that promotes investor protection by conducting and supporting research and education programs.

GLOSSARY
Accrued interest— Interest that is due, on a bond for example, but that hasn’t yet been paid.

Bond— An interest-bearing security that obligates the issuer to pay a specified amount of interest for a specified time, usually several years, and then repay the bondholder the face amount of the bond.

Bond rating— A judgment about the ability of a bond issuer to fulfill its obligation to pay interest and repay the principal when it is due.

Call— The ability of a bond issuer to redeem a bond before its maturity date.

Capital gain (loss)— The difference between the price at which you buy an investment and the price at which you sell it.

Coupon rate— A way of expressing bond yield, this is the fixed annual interest payment expressed as a percentage of the face value of the bond. A 9% coupon bond, for example, pays $90 interest a year on each $1,000 of face value.

Face value— The amount an issuer pays to a bond holder when the bond reaches full maturity.

Maturity— The amount of time it takes for a bond to pay the face value. Bonds are issued with varying maturity dates.

Mutual Fund— A professionally managed portfolio of stocks and bonds or other investments divided up into shares.

Prospectus— A document that describes a securities offering or the operations of a mutual fund.

Risk— The possibility that you may lose some (or all) of your original investment. In general, the greater the potential gain from an investment, the greater the risk is that you might lose money.

Secondary market— The general name given to marketplaces where stocks, bonds, mortgages and other investments are sold after they have been issued and sold initially.

Stock— A share of stock that represents ownership in the company that issues it. The price of the stock goes up and down, depending on how the company performs and how investors think the company will perform in the future.

Yield— In general, the annual cash return earned by a stock, bond, mutual fund or other investment. Bond yields can take many forms. Coupon yield is the interest rate paid on the face value of the bond. Current yield is the interest rate based on the actual purchase price of the bond, which can be higher or lower than the face value.

Yield to maturity is the rate that takes into account the current yield and the face value, with the difference assumed to be amortized over the remaining life of the bond.

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