Understanding Bonds

Radio Transcript, 2 minutes 20 seconds, for use during week of Oct. 22.

Description: Penny, Susan and Ira talk about investing in bonds.

Susan: Penny, we’ve talked quite a bit about stocks and mutual funds and some of the things that Ira and I should think about, which has been really helpful.  I was wondering if we could talk about bonds.

Penny: Sure.  What is your question?

Ira: What makes bonds different from stocks?

Penny: Stocks can be considered ownership investments, which means you own all or part of the investment.  Bonds, on the other hand, are loans. You loan your money to a government entity, corporation, or financial institution and, in return, you receive regular interest at a specified time period.

Susan: So I might receive payments once a year or twice a year?

Penny: Yes.  Payments at specified dates is one of the advantages of fixed-income investments.  Another advantage is that bond ownership can help you diversify your investment holdings.

Ira: So – I’ve got another question.  How is the rate of interest for a particular bond determined?

Penny: This depends on what is happening in the economy.  Interest paid on a newly issued bond is based on the current rate at the time for bonds of a similar risk. 

Susan: So certain bonds might pay me more interest, but I would be taking a greater risk investing in them?

Penny: Yes.  Also, once bonds are issued, their market value rises or falls based upon changes in the current interest rates.  This isn’t an issue if you hold your bond until it matures but if you want to sell a bond before its maturity, you may receive more or less than the face amount of the bond. 

Ira: When I buy a bond is it for a specific period of time?

Penny: That’s right.  You can purchase bonds for many different maturities.   Bonds which mature in 20 to 40 years are long term bonds.  Those that mature in 3 to 20 years are intermediate term bonds.  And bonds which mature in 3 years or less are considered short term.

Susan: Thank you, Penny.  As always —lots to think about!

Penny: Thank you.  And, don’t forget, for more information, visit the ISU Extension website at extension.iastate.edu and look for ‘Invest Wisely.’