A debt instrument that lasts for a period of longer than one year. Bond investors are loaning money to a government or institution for a specified period usually with a set rate of interest. Governments, utilities, and companies often issue out bonds to finance different projects.
Issuing bonds is a way to borrow money, often for large projects such as parking garages or factories that are too expensive to pay for with current funds in a single payment. A bond is the borrower’s promise to repay a set amount of money, plus periodic interest, on a specific date.
Unlike a car loan or a house mortgage, a government’s borrowing is structured differently. Instead of establishing a repayment schedule based on a single interest rate and single maturity date, when a government issues bonds, the repayment schedule is based on multiple maturity dates with different interest rates. Thus, at any given time, the government may owe money to thousands of different individuals, businesses, or governments holding its bonds and not just to a single lender.
Both private businesses and government entities issue bonds, and bonds share common characteristics:
· The issuer is the entity borrowing money, such as a state or local government.
· The bond’s par or face value is the amount of money that will be repaid at the bond’s maturity date. Most municipal bonds are issued in multiples of $5,000, requiring a rounding up or down of the amount borrowed.
· The bond’s coupon or coupon rate is the interest rate that will be paid to the bondholder, often every six months. For example, a $5,000 bond with a 5 percent coupon will pay $250 in interest each year, or $125 every six months.
A bond may be bought, sold, and held by many investors over its life before it is paid off. When bonds are originally issued or are traded later on the secondary market, they may not sell for their par amount. A bond’s price depends on how its coupon rate compares to current interest rates on the market for similar investments. If a bond’s coupon rate is lower than the market rate, the bond will be less attractive to investors and will sell for less than its par amount, or at a discount.
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