Bonds represent a loan made to the issuer of the bond. Bonds can be taxable or tax-exempt and are issued by a corporation, the United States government, a United States government agency or municipality.
When you buy a bond, you lend the bond issuer the face value of the bond. As the investor, you receive income based on the bond’s coupon rate over the life of the bond, as well as the principal (or face value) when the bond reaches its maturity. If you buy bonds directly from the issuer and hold them until maturity, bond investing is fairly straightforward.
Bond investing gets more complex if you buy bonds on the secondary market, where bonds are traded above or below face value (at a premium or discount), or if you sell the bond before maturity and interest rates have changed. In essence, your return on investment is the difference between what you paid for the bond and what you realize when you sell it or it matures.
Fluctuating interest rates, bond supply and demand, and the bond issuer’s financial health can all affect both the purchase and sale price on your investment.
Typically, bonds pay a fixed rate of interest at regular intervals and have a definite maturity date. Once a bond matures, unless the bond is redeemed prior to maturity by the issuer, the investor is typically paid the face value of the bond.