How Bonds Work

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Clearly, bonds are one way our public and private institutions borrow billions and billions of dollars. A bond is similar to a loan or an IOU. When you purchase a bond, you are like a mini-banker lending to a large borrower, such as a corporation or government entity.

The borrower (the issuer of the bond) makes a legal promise to repay the amount borrowed back (known as the principal or the bond’s par or face value) to the bondholder on a specific future date (known as the redemption or maturity date) plus interest (known as the coupon rate or coupon) at a periodic rate, usually twice a year. For the borrower or issuer, the interest expense is the cost of borrowing; for the investor, the dependable interest income is compensation for lending the money.

Investments in bonds have burgeoned since the beginning of the 21st Century. Today’s U.S. bond market exceeds a hefty $34 trillion. The bond market is collectively made up of an array of sectors within the credit market, with each category of bond consisting of its own network and trading system.

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