• Bonds are different from stocks in a fundamental way.
  • When you purchase a stock, you are BUYING a piece of the company.
  • When you purchase a bond, you are LENDING your money to the company.
  • Bonds are simply "contracts" that state a government or company is obligated to pay you a fixed interest and the original loan amount back in full on the maturity date.
  • The maturity date is simply the date on which the "matures"  or expires.
  • In our example, you lend $1000 to Microsoft Corporation at an interest rate of 5% and maturity date of 5 Years.
  • So, after the first full year, Microsoft pays you 5% of the $1000 you lent them, which is 50$.
  • The next year, you recieve $50 again!
  • The same goes for the third and fourth year.
  • Then, at the end of the fifth year, which is the maturity date, Microsoft pays you the interest of the final year as well as you original investment.
  • So at the end of the fifth year you recieve $1050.
  • In total, you have recieved $250 in interest over the course of five years! Not bad, right?
  • Now, there are some risks involved just like with every investment.
  • The main risk you face as a bondholder is that the company defaults. In other words, it cannot pay you your loan back!
  • However, in case the company goes bankrupt, all the money that the company is able to collect, goes to debt holders first.
  • Beng a bond holder you are debt holder.
  • Equity holder or stock holders, get paid last....
  • The bond process is the same when you buy from a government, only now your risk of default is a lot lower, depending on the government you lend money to.
  • Lower risk means lower rewards and therefore interest rates on government bonds aren't as high as on corporate bond.