Investing in Bonds
Bonds are issued with certain specified reimbursement dates and posted interest rates. The bond issuer is obligated to redeem the principal amount of the bond to the bond holder, either at the redemption date or “on demand”, according to the issuing terms. As well, the bond issuer must pay the holder annual interest on the principal amount. This can be done in several ways. Compound interest bonds add each year’s interest amount to the principal and calculate the next year’s interest payment on the increased amount, and so on until the redemption date. Other bonds pay interest annually through the redemption of “coupons” attached to the bond. On these types of bonds, only the principal amount is redeemed at the end of the term.
Government bonds historically have been the most secure investments in most people’s minds, but the downside of this is that the interest rates they pay are on the whole lower than that paid by corporate bonds. For example, Japanese government bonds pay some of the lowest interest rates in the world, around 1 to 1.5 percent annually. On the other end of the scale, so-called “junk bonds” issued by companies with dubious credit ratings are obliged to offer very high interest rates to induce investors to purchase them, as a counterbalance to the vastly increased risk investors must accept.
Bonds, especially government bonds, are popular gifts for newlyweds and new babies as they denote the confidence on behalf of the giver that the future will be secure and prosperous. Investors who buy bonds are also pledging their confidence that the company or government issuing the bonds will still be around in the future to redeem the bonds. Perhaps the most noted expression of this type of confidence occurred during World War II when people used badly needed savings to purchase war bonds.
In many respects, the word “bond” means more than just a financial security, it is an expression of the bond between investors and issuers as integral components of the ongoing economic engine!