i know this is a broad topic so some leading questions would be
how is price determined
what is maturity
what are different types of bonds
how does the government use the money
Analogies make explanations a lot easier, for I am not smart.
In: Economics
Some key terms highlighted:
A bond is a common type of debt security. **Security** just means it is fungible, can be traded between people, and has some sort of financial value. With the exception of extremely short-term debt, most bonds pay some sort of **interest** rate. This is also sometimes called a **coupon** rate and the payment of the interest is sometimes called the coupon payment. This is because older bonds were bearer bonds, meaning there was no record of who owned them and you needed the physical bond itself to be paid. They literally had coupons attached to them that you could clip off and redeem for payment.
Bonds will usually pay interest twice per year until the date they **mature**, when the last interest payment is made plus the **face amount** of the bond (the loan is repaid). The face amount of most types of bonds is always the same: $1,000. This is also sometimes called the **par value**.
An important thing to realize is that the face amount and the interest payment of any given bond do not change over time. (With rare exceptions.) However **bond yields** do change over time. How is this possible? Because the price of the bond changes over time. If I buy a 5-year bond when it is first auctioned, I will usually pay around par value–$1,000. However let’s say a year from now the borrower gets sued and their credit rating drops, or perhaps interest rates in general are just higher. If I try to sell that bond to another investor, I am not going to get $1,000 anymore because it doesn’t pay enough interest. Instead I may only get $950 when I sell it. Since the person purchasing the bond only had to pay $950, the bond yield has increased. They will receive the same coupon payment and $1,000 payment at maturity, despite investing less, so obviously the overall return has increased. When a bond sells below its par value of $1,000, this is called selling at a **discount**. When it sells above its par value, it’s selling at a **premium**.
Bonds can have all kinds of maturities, anywhere from months to decades. And there are also lots of special exceptions to everything I just wrote. For example, “**stripped bonds**” are bonds (or derivatives of bonds) where an intermediary will “strip off” the coupon payments and sell them to one investor and then sell the face amount payment to another investor. And even though most bonds have a set coupon payment and par value, there are exceptions there as well; notably “**I Bonds**” and “**TIPS**,” (Treasury Inflation Protected Securities), which are two different types of US Government debt that adjust their return based on the consumer price index, in order to protect the buyer from rising inflation rates.
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