Basically, an IOU issued by a company in order to raise money. When you buy a bond, you are essentially loaning money to a company with the understanding that you will receive what you invested along with a fixed amount of interest (also called the coupon) at some future date. The future date when you receive this cash is called the bond’s maturity date.
Here is a simple example to help you understand the concept. Let’s say your best friend wants to expand his business and he needs $5,000 to do this. He promises that he will repay you $5,250 a year from now. In this case, the bond is represented by the $5,000 loan you gave to your friend to help him raise money for the business expansion. The interest rate (or coupon) was 5% and the maturity date was 12 months from the date the bond was purchased.
Many people invest in bonds because bonds offer a stream of steady income (e.g., fixed income). For example, suppose you invest $10,000 in a bond with a coupon of 5% and a maturity of 10 years. Every year for 10 years, you would receive a fixed income of $500 (5% of $10,000). At the end of 10 years, you would get back your $10,000 initial investment.
There are two interesting things to note about this example:
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