What Are Bonds?
Have you ever borrowed money? Of course you have! Whether we hit our parents up for a few bucks to buy candy as children or asked the bank for a mortgage, most of us have borrowed money at some point in our lives.
Just as people need money, so do companies and governments. A company needs funds to expand into new markets, while governments need money for everything from infrastructure to social programs. The problem large organizations run into is that they typically need far more money than the average bank can provide. The solution is to raise money by issuing bonds (or other debt instruments) to a public market. Thousands of investors then each lend a portion of the capital needed. Really, a bond is nothing more than a loan for which you are the lender. The organization that sells a bond is known as the issuer. You can think of a bond as an IOU given by a borrower (the issuer) to a lender (the investor).
For example, say you buy a bond with a face value of Rs.1,000, a coupon of 8%, and a maturity of 10 years. This means you’ll receive a total of Rs.80 (Rs.1,000*8%) of interest per year for the next 10 years. Actually, because most bonds pay interest semi-annually, you’ll receive two payments of Rs.40 a year for 10 years. When the bond matures after a decade, you’ll get your Rs.1,000 back.