On Tuesday, we took a closer look at stocks and what they are. Today, we’re going to focus on bonds and the role they play in a financial portfolio. A bond is a popular choice for investors as they help diversify portfolios and typically pay out interest semi-annually. There are also several options in which a person can choose to invest.
WHAT IS A BOND?
According to Investopedia, a bond is a fixed income investment in which an investor loans money to an entity (usually corporate or government) which borrows the funds for a defined period of time at a variable or fixed interest rate.
Often times, a company will issue bonds instead of going to a financial institution for a loan. This money will go towards new projects, cover existing debt, etc. The bondholder’s investment will be paid back by a certain date, called the maturity date, which also includes interest.
HOW DO THEY AFFECT MY PORTFOLIO?
There are two main determinations for how much the interest will be: credit quality and duration. Credit quality is the rating of the company that is issuing bonds. The lower their rating is, the higher the risk the bond has of defaulting. Duration is how the price will be affected by interest rates during the time which the bond is held.
The price of a bond is dependent upon many factors, such as: interest rates, tax status, maturation date, and more.