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What is a Bond?

Mark LaMonica, CFA  |  02 Jan 2018Text size  Decrease  Increase  |  
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Bonds are more stable than stocks but riskier than term deposits or money market accounts. They are not great for making your money grow rapidly, but they can help to diversify your portfolio. Most traditional bonds provide a relatively stable source of interest payments and a return of your principal.

The purchase of a bond is basically a loan to the issuer: a loan that must be repaid to you at maturity. Bonds differ in their maturity.

Maturity is the time at which a bond issuer pays you back the money you loaned. If you hold your bond until it matures, you get back all of the money you paid for it, unless the issuer has defaulted. Shorter-term bonds have maturities of only several years. Long-term bonds take from 10 to 30 years to mature. In general, the longer the maturity, the greater the total of interest payments you will receive from the bond.

If you would like to conservatively invest money for a major purchase to be made within the next few years, consider a short-term bond. These types of bonds will generally maintain your principal without much risk. If the timeline of your investment is longer, you may want to consider a longer-term bond.

Long-term bonds will typically offer a higher yield in exchange for the use of your money for a longer period.

The bond issuer may decide to pay off a bond before its maturity date. This is known as "calling" a bond. Bonds are called because an issuer no longer needs to borrow the money, or because interest rates have fallen and the issuer wants to issue new bonds at a lower interest rate.

A bond's market value is directly related to interest rates. As interest rates go up, the market prices of bonds go down and vice versa. Until a bond matures, its price on the secondary market constantly changes in response to changes in interest rates. If you sell your bond before it matures, the price may be more or less than you originally paid for it, depending on current interest rates.

The other factor affecting the prices of bonds is the credit quality of a bond. If a bond issuer is at risk for default, it will be assigned a low credit rating. Credit ratings are based on a grading system, with AAA being the highest possible mark, all the way down to a grade of C. Rating agencies include Moody's Investors Service and Standard & Poor's.

 

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Mark Lamonica is a product manager, Individual Investor, Australia.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is a product manager, individual investor, Australia.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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