Definition of Bond

A debt instrument issued for a
period of more than one year
with the purpose of raising
capital by borrowing. The
Federal government, states,
cities, corporations, and many
other types of institutions sell
bonds. Generally, a bond is a
promise to repay the principal
along with interest (coupons) on
a specified date (maturity). Some
bonds do not pay interest, but
all bonds require a repayment of
principal. When an investor buys
a bond, he/she becomes a
creditor of the issuer. However,
the buyer does not gain any kind
of ownership rights to the issuer,
unlike in the case of equities. On
the hand, a bond holder has a
greater claim on an issuer's
income than a shareholder in
the case of financial distress (this
is true for all creditors). Bonds
are often divided into different
categories based on tax status,
credit quality, issuer type,
maturity and secured/unsecured
(and there are several other
ways to classify bonds as well).
U.S. Treasury bonds are
generally considered the safest
unsecured bonds, since the
possibility of the Treasury
defaulting on payments is almost
zero. The yield from a bond is
made up of three components:
coupon interest, capital gains
and interest on interest (if a
bond pays no coupon interest,
the only yield will be capital
gains). A bond might be sold at
above or below par (the amount
paid out at maturity), but the
market price will approach par
value as the bond approaches
maturity. A riskier bond has to
provide a higher payout to
compensate for that additional
risk. Some bonds are tax-
exempt, and these are typically
issued by municipal, county or
state governments, whose
interest payments are not subject
to federal income tax, and
sometimes also state or local
income tax.