Bonds

Bonds are the way institutions take out a loan from the public.  The National Debt, at $16.7 trillion dollars, includes treasury bills, notes and bonds sold to institutions and personal investors around the world.  Municipal bonds are the same thing except that they are sold by municipalities (cities, states, etc.) for various public works projects.  Corporation can also issue bonds.  Corporate finance includes making sure the right amount of money is financed through stock issuance and bond issuance.

Bonds are issued based on an interest rate and a maturity date.  For example a bond could be issued at $9000 and mature in 10 years worth $10,000.  A bond could be issued at $100 and mature in 10 years worth $100, but pay a 2% coupon annually (in this example $1 every 6 months for 10 years). 

Bonds are a little trickier to buy and sell.  Treasury bonds are pretty easy for individuals.  They are bought through treasurydirect.gov and held to maturity.  Shop4Bonds is a website that offers bonds online.  To buy an individual bond, call your broker, tell him what you are interested in, the broker will quote a price (which includes a commission) and you can purchase the bond.  It is the same thing to sell.  Bonds are less liquid than stocks.

If a company goes bankrupt, the bondholders will get a share of what is left of the company before shareholders (who usually get nothing).

Bond funds hold a smattering of bonds and are usually classified as long term (duration of 10+ years), short term (less than 1 year) or intermediate term.  They are also classified as High yield (risky) or Investment grade (less risky).  Finally they are classified as corporate, municipal (tax exempt depending on where you live) or treasury (backed by the full faith and credit of the US Government).  The credit rating of the US Government recently went from AAA (outstanding) to AA+ (excellent).

The longer the duration of a bond the more volatile it is.  Longer duration bonds offer higher returns.  The lower the credit rating of the issuing entity the more risky it is.  Low credit ratings mean higher returns as long as the issuing entity does not default.