Wealth &
Protection Planning

Bonds

Bonds represent debt owed by the company to the bondholders.  Companies, municipalities, the federal government, and government agencies issue bonds.  Bonds fund specific purposes such as corporate operations, schools and roads, and government financing.  In exchange for the use of this money, the issuer promises to pay the bondholders' periodic interest and return their principal on a specific maturity date.  Interest on corporate bonds is taxable, while municipal bond interest is usually federal income tax exempt and may be state income tax exempt also.  Interest on U.S. government or government agency bonds may be state tax exempt. 

The value of bonds will fluctuate based on the fluctuation in short- and long-term interest rates.  This is known as interest rate risk, or the risk that the value of the bond will fall due to rising interest rates.  As interest rates rise, bond prices fall, and as interest rates fall, bond prices rise.  If the investor needs to sell the bond before maturity, depending on current interest rates, he or she may not receive the original investment cost. 

Bonds also have credit risk which is the risk that the bond issuer will be unable to repay the principal at the time of maturity.  The creditworthiness, or ability of the company to repay the bond, is analyzed by several independent firms and then given a rating.  The ratings range from "AAA" to "D" and show the likelihood that the company will be able to make the periodic interest payments and repay the bonds. 

The final type of risk involved in buying bonds is prepayment risk.  This is the risk that the investor will receive his or her principal back before maturity.  This typically happens when interest rates fall, allowing the issuer to call the bonds with the higher interest rates and reissue bonds with lower interest rate payments.  The risk for the investor is that he or she may have to reinvest that money into the market at the new lower interest rates. 

Contact a STRIVE Wealth Advisor for more information about bonds. 

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