What are bonds?

A bond is a debt security, similar to an IOU. Borrowers issue bonds to raise money from investors willing to lend them money for a certain amount of time.

When you buy a bond, you are lending to the issuer, which may be a government, municipality, or corporation. In return, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the principal, also known as face value or par value of the bond, when it "matures," or comes due after a set period of time.

Why do people buy bonds?

Investors buy bonds because:

• They provide a predictable income stream. Typically, bonds pay interest twice a year.
• If the bonds are held to maturity, bondholders get back the entire principal, so bonds are a way to preserve capital while investing.
• Bonds can help offset exposure to more volatile stock holdings.

What are the benefits and risks of bonds?

Bonds can provide a means of preserving capital and earning a predictable return. Bond investments provide steady streams of income from interest payments prior to maturity.

The interest from municipal bonds generally is exempt from federal income tax and also may be exempt from state and local taxes for residents in the states where the bond is issued.

As with any investment, bonds have risks. These riskes include:

Credit risk. The issuer may fail to timely make interest or principal payments and thus default on its bonds.

. Inflation risk. Inflation is a general upward movement in prices. Inflation reduces purchasing power, which is a risk for investors receiving a fixed rate of interest.

Liquidity risk. This refers to the risk that investors won’t find a market for the bond, potentially preventing them from buying or selling when they want.

Call risk. The possibility that a bond issuer retires a bond before its maturity date, something an issuer might do if interest rates decline, much like a homeowner might refinance a mortgage to benefit from lower interest rates.