Bonds

You can invest in bonds. It is the opposite of taking out a loan - instead you are issuing a loan to a company or the government.

The par value or face value is the amount of the loan, 1 bond typically represents $1000.

If you own a bond there could be interest payments attached to the bond. For corporate bonds, interest is usually paid semi-annually.

The payment amount is calculated from the par value. e.g. a 5% semi-annual bond might pay $25 in March, and $25 in September.

The maturity date is when the bond becomes due. The bond holder will be paid the $1000 par value at this date.

The price of a bond fluctuates on the market. Even though the par value is $1000, the price of bond can rise or fall.

The yield is calculated using the bond's interest rate and the current market price of the bond.

The yield of a bond can depend on the maturity date. For treasury bonds this is known as the yield curve. Normally, longer term bonds (bonds with later maturity dates) will command a higher interest rate. This is to compensate the lender for inflation and increased risk that the issuer will default during the longer timeframe.

Other price factors include seniority of the bond. In the event of default or bankruptcy, more senior bonds will be repaid before less senior bonds.

The perceived risk of the issuer will also factor into the price. A company deemed risky (maybe it has a poor balance sheet) will have to pay higher interest rates on their debt. This is similar to people with poor credit ratings having to pay more to borrow money. And it is also the reason why if you put a larger deposit down for your mortgage you can get a better rate from the bank - you are deemed to be less risky.

Operation Twist

On 22nd September, 2011 the Fed announced "Operation Twist". This is designed to modify the yield curve, making it less expensive to borrow longer term. The will purchase $400bn of long term treasuries and sell the same amount of short term treasuries. This has the effect of making the yield on long term treasures lower, encouraging longer term borrowing because it is now cheaper.