Bonds are purchased by individuals to make money on the interest paid out periodically by the bonds. In return for earning interest the investors are loaning money to corporations. The corporations need to gather funds and this can be done in two major ways. The issuance of stock, both common and preferred, along with raising money by going into debt. The debt aspect is in the guise of bonds.

There are government bonds, both Federal, state and those issue by municipalities along with corporate bonds. Government bonds that are guaranteed by revenue pay a lower interest rate than corporate bonds, because there is less risk involved.

Corporate bonds can be purchased as part of a bond fund or individually. Bonds like stocks are traded in the market, meaning they do not have to be held to maturity. When traded, commissions are paid by both parties to the trade, and whether you made or lost money on the bonds is determined by the market conditions.

Corporate bonds can be from old line companies like Caterpillar which is not likely to go out of business. They range from this type of company down to junk bonds, issued by risky companies. The riskier the company the less likely they will be around to pay the bonds. If this happens the money is lost.

When General Motors and Chrysler were partially taken over by the U.S. government, many bondholders lost all their money or some of their money. Losing some of their money is known on Wall Street as “taking a haircut.”

Bonds are rated by firms such as Moody’s, Standard & Poor’s and other minor rating agencies. A triple A rating would be practically risk-free down to lower ratings like the B category which are more risky. Obviously those wishing to earn more money take a greater risk by purchasing junk bonds and others below the Triple A rating.

This is not to say the investor will lose money. Some companies thought of as risky turn out to be successful and the interest paid on their debt is quite high. Money market funds are a mixture of government bonds and highly rated corporate paper, another word for debt. They pay little interest because the investment is almost risk-free.

During the Great Recession a couple of money market funds “broke the buck” in Wall Street parlance. This means they dropped below a dollar, a rare occurrence indeed. Corporations must borrow in the money market to stay in business, so the government for a time guaranteed money market funds like savings accounts.

Keep learning more:

1. The Disadvantages of Investing in Bonds


2. The Advantages of Investing in Bonds


3. Inflation is the Biggest Risk of Bond Investing


4. The 3 Basic Types of Mutual Funds

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