Fixed Income Investments
Bonds are an essential component of a diversified investment portfolio, offering you a regular stream of income and a return of principal at maturity. In this chapter, we will explore the basics of bond investing, discussing what bonds are, the different types of bonds, and how bonds generate income.
What are Bonds?
Bonds are debt securities issued by companies and governments to raise capital. When you purchase bonds, you lend money to the issuer, who promises to repay the principal at maturity and make regular interest payments.
Definition and Features: Bonds are characterised by their face value, coupon rate, maturity date, and credit rating. The face value is the principal amount borrowed, the coupon rate is the interest rate paid periodically, the maturity date is when the bond expires, and the credit rating reflects the issuer's creditworthiness.
How Bonds are Issued: Bonds are issued through underwriting, where investment banks purchase the bonds from the issuer and sell them to investors.
Types of Bonds
There are several types of bonds that you can purchase:
Government Bonds: Government bonds are issued by national governments to finance their activities. They are considered to be very low-risk and offer a fixed return.
Corporate Bonds: Corporate bonds are issued by companies to raise capital for various purposes, such as expanding their business or refinancing debt. They offer a higher return than government bonds but come with a higher level of risk.
Municipal Bonds: Municipal bonds are issued by local governments and other public entities to finance infrastructure projects and other activities. They offer a tax-free return and are considered to be relatively low-risk.
High-Yield Bonds: High-yield bonds are issued by companies with a credit rating below Baa3 from Moody's, or BBB- from Standard and Poor's (S&P) and Fitch. They offer a higher return to compensate for the increased risk.
How Bonds Generate Income
Bonds generate income through regular interest payments and the return of principal at maturity:
Interest Payments: Bonds make periodic interest payments to the bondholder, known as coupon payments. The coupon rate is determined at issuance and remains fixed throughout the bond's life.
Return of Principal: At maturity, the issuer repays the principal amount to the bondholder, providing a return of capital.
Key Takeaways
By understanding the basics of bond investing, you can begin to build a well-balanced investment portfolio that provides steady income and capital preservation.
In the next chapter, we will explore the world of real estate investing, discuss the different types of real estate investments, and outline how you can get started in the real estate market.