6. What is a bond?

What is a Bond?

Nothing more than a loan.

Who uses bonds?

Corporation, Government

Bond Risks

• Company or Government Failure
• Interest Rates Change
• Inflation

Provided corporate liquidations/failure, the order of equity distribution:

• Bond holders
• Preferred share holders
• Common share holders

Why is bond investing lucrative

Before market crashed in around 2008, 30 year federal bond rate had been 5.00% and DJI's average P/E ratio had been 27, implying the return is 3.7%. After the market crashed, it became 2.83% and 6.7% (from P/E ratio being 15), respectively.

If A bought 30 year 5% federal bond of $1,000 par value, the price of A's 5% bond becomes worth $1,418. At the end of 30 years, he would get $1500 ($50 * 30) from coupons bringing the total to $2500 ($1000 + $1500). Now that the interest rate is 2.83%, if Mr B wants to buy A's bond, he would have to invest $1418 now instead of $1000.