What is a Bond?

A bond, also known as a fixed-income security, is a

debt instrument created for the purpose of raising capital.
They are essentially loan agreements between the bond
issuer and an investor, in which the bond issuer is
obligated to pay a specified amount of money at specified
future dates.
Why do Bonds matter?
Bonds and other fixed-income securities play a critical
role in an investor's portfolio. Owning bonds helps to
diversify a portfolio, as the bond market doesn't rise or
fall alongside the stock market. More important, bonds
are generally less volatile then stocks, and are usually
viewed as a "safer" investment.
How do Bonds work?
When an investor purchases a bond, they are "loaning"
that money (called the principal) to the bond issuer, which
is usually raising money for some project. When the bond
matures, the issuer repays the principal to the investor. In
most cases, the investor will receive regular interest
payments from the issuer until the bond matures.
Different types of bonds offer investors different options.
For example, there are bonds that can be redeemed prior
to their specified maturity date, and bonds that can be
exchanged for shares of a company. Other bonds have
different levels of risk, which can be determined by its
credit rating. Bond rating agencies like Moody's and
Standard & Poor's (S&P) provide a service to investors by
grading fixed income securities based on current research.
The rating system indicates the likelihood that the issuer
will default either on interest or capital payments.
Why Invest in Bonds?
 Unlike stocks, bonds issued by companies give you no
ownership rights. So, you don't necessarily benefit from the
company's growth, but you won't see as much impact when the
company isn't doing as well, either—as long as it still has the
resources to stay current on its loans.
Bonds, then, give you 2 potential benefits when you hold
them as part of your portfolio: They give you a stream of income,
and they offset some of the volatility you might see from owning
stocks.
Bonds can provide a means of preserving capital and
earning a predictable return. Bond investments provide steady
streams of income from interest payments prior to maturity.
Benefits of investing in Bonds:
+ Current income - they can provide current income for
conservative investors. Bonds are issued by governments and
corporations when they want to raise money. By buying a bond,
you're giving the issuer a loan, and they agree to pay you back
the face value of the loan on a specific date, and to pay you
periodic interest payments along the way, usually twice a year.
+ Tax free - some bonds can provide tax free income. The
interest from municipal bonds generally is exempt from federal
income tax and also may be exempt from state and local taxes
for residents in the states where the bond is issued. Tax-free
bonds generally have a long-term maturity of ten years or more.
The government invests the money collected from these bonds in
infrastructure and housing.
+ Capital gains - at times they can provide capital gains (or
losses) for more aggressive investors. If you sell a municipal bond
for a profit before it matures, you may generate capital gains.
Long-term capital gains (which require a 12-month holding
period) resulting from the sale of tax-exempt municipal bonds are
currently taxed a maximum rate of 15%. Of course, if you sell
your security for less than your original purchase price, you may
incur a capital loss. In short, you can profit if you resell bonds in a
higher price.
+Preservations - they can be used for preservations and
long term accumulation of capital. Capital preservation is an
investment strategy that aims to preserve capital and prevent
loss of a portfolio. When using this investment strategy, investors
opt for safe assets such as Treasury bills and certificates of
deposits (CDs). Investors who use this strategy tend to be risk-
averse and have a short time horizon. Often, retirees or those
approaching retirement will use this investment strategy to
preserve funds to support their lifestyle after they stop working.
RISKS OF INVESTING BONDS-
Risk is an inherent part of investing. Generally, investors must
take greater risks to achieve greater returns, however taking on
additional risk does not always lead to greater returns. Investors
who take on additional risk, must be comfortable with
experiencing significant periods of underperformance in the
expectation of achieving higher returns over the longer term.
Those who do not bear risk very well have a relatively smaller
chance of making high earnings than do those with a higher
tolerance for risk; similarly, they have a smaller chance of making
significant losses. It's crucial to understand that there is an
inevitable trade-off between investment performance and risk.
Higher returns are associated with higher risks of price
fluctuations. As an investor, you should be aware of some of the
pitfalls that come with investing in the bond market. Here are
some of the most common risks:
1. Interest Rate Risk
Rising interest rates are a key risk for bond investors. Generally,
rising interest rates will result in falling bond prices, reflecting the
ability of investors to obtain an attractive rate of interest on their
money elsewhere. Remember, lower bond prices mean higher
yields or returns available on bonds. Conversely, falling interest
rates will result in rising bond prices, and falling yields. Before
investing in bonds, you should assess a bond’s duration (short,
medium or long term) in conjunction with the outlook for interest
rates, in order to ensure that you are comfortable with the
potential price volatility of the bond resulting from interest rate
fluctuations.
2. Inflation Risk
Inflation reduces the purchasing power of a bond’s future
coupons and principal. As bonds tend not to offer extraordinarily
high returns, they are particularly vulnerable when inflation rises.
Inflation may lead to higher interest rates which is negative for
bond prices. Inflation Linked Bonds are structured to protect
investors from the risk of inflation. The coupon stream and the
principal (or nominal) increase in line with the rate of inflation and
therefore, investors are protected from the threat of inflation. For
example, if an investor purchases a 5% fixed bond, and inflation
rises to 10% per year, the bondholder will lose money on the
investment because the purchasing power of the proceeds has
been greatly diminished. The interest rates of floating-rate bonds
or floaters are adjusted periodically to match inflation rates,
limiting investors' exposure to inflation risk.
3. Reinvestment Risk
When interest rates are declining, investors may have to reinvest
their coupon income and their principal at maturity at lower
prevailing rates.
4. Default Risk
Default risk occurs when the bond's issuer is unable to pay the
contractual interest or principal on the bond in a timely manner or
at all. Credit rating services such as Moody's, Standard & Poor's,
and Fitch give credit ratings to bond issues. This gives investors
an idea of how likely it is that a payment default will occur. If the
bond issuer defaults, the investor loses part or all of their original
investment plus any interest they may have earned.
STOCKS VS. BONDS
 A stock represents a collection of shares in a company
which is entitled to receive a fixed amount of dividend at the end
of relevant financial year which are mostly called as Equity of the
company, whereas bonds term is associated with debt raised by
the company from outsiders which carry a fixed ratio of return
each year and can be earned as they are generally for a fixed
period of time. They are used for making quick money or even
from the perspective of keeping its investments since the
prospects of growing money are relatively higher in this case.
Other macroeconomic factors also have an impact on the
performance of these stocks or bonds which also needs to be kept
in mind.
A stock indicates owning a share in a Corporation
representing a piece of the Firm’s assets or earnings. Any person
who is willing to make a contribution to the capital of the
company can have a share if it is available to the general public.
On the other hand, bonds are actually loans that are
secured by a specific physical asset. It highlights the amount of
debt taken with a promise to pay the principal amount in the
future and periodically offering them the yields at a pre-decided
percentage.