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How do bonds work?


Bond Terminology

Bonds may have characteristics that are good for the buyer (that would be you), the seller or both. Here are some terms you should be familiar with before selecting a bond:

  • Maturity - Bonds have lifetimes. Depending on the type of bond, that lifetime can last anywhere from one month to 50 years. ­­
  • Callability - This is a term that means the company or agency that issued the bond has the right to call the bond back in at a time of their choice. In other words, the company buys the bond back before it matures. An agency might do this when interest rates are falling in order to issue new bonds at lower rates so it'll save money. This isn't always a bad dea­l for those who bought the bonds, either, because there is an extra premium added to the face value of the bond.
  • Put provision - Just as callability allows the seller to call the bond back before it matures, some (but not too many) bonds have a put provision that gives the person who bought the bond a chance to sell it back at face value before it matures. It can't be done at any time, however; the seller must schedule this ahead of time. People who own bonds sometimes put their bonds when interest rates are rising so they can invest their money where it will earn more.
  • Convertible bonds - Sometimes bonds can be converted into stock in the company that issued them. At the time the convertible bonds are issued, exactly when and at what price they can be converted to stocks is specified. This type of bond usually offers lower interest rates initially, but it also offers the potential for higher earnings as a stock.
  • Secured bonds - Bonds that are backed by collateral are called secured bonds. This means that the company or agency that issued the bond also has money or assets to cover the bond's value. Money or the assets would be given to the people who bought the bonds in the event that the company goes bankrupt.
  • Unsecured bonds - Also called debentures, unsecured bonds are not backed by collateral; they're simply backed by the creditworthiness of the company or agency issuing the bonds. Government bonds are unsecured because the U.S. government is so creditworthy.

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­Bonds are much more complicated than we've explained here and have a lot more terms to describe their different features. For even more insight into bonds, follow the links on the next page.