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UNIVERSITY OF ILLINOIS College of Business - Department of Finance - Finance 300 (Financial Markets) Professor James Jackson Debt Investments Bonds are sometimes described as debt securities and sometimes as fixed-income investments. If you understand what each of these terms means, you understand how bonds work. When you buy a bond, you’re actually lending the issuer money that you expect to get back. That’s the debt. The issuer pays interest for the use of your money, typically on a set schedule. That’s the fixed income. People often think of bonds as a more conservative investment than stock. It is true that you can buy them at issue and hold them until maturity, so that what is happening to bond prices in the marketplace doesn’t affect you. But changing demand does affect the price, so you can also trade bonds to realize capital gains from selling for more than you paid to buy them. You can create a diversified portfolio by purchasing bonds of different terms, from different issuers, and with a range of ratings. Long-Term Investments From AAA-rated municipals to high-yield corporate (bonds), from bonds with maturities of a month to those with maturities of 100 years, from zero-coupon convertibles to mortgage-backed bonds, there’s more variety among bonds than you might think. A bond is a debt investment. When you buy a bond, you invest by lending money to a corporation, government, or government agency that issues, or sells, the bond. The issuer has the use of the money for a specific term, or period of time, and promises to repay the loan, or principal, when the bond matures at the end of the term. The issuer also promises to pay interest, figured as a percentage of the par value, or face value, of the bond for the term. Bonds are also known as fixed-income investments because you earn interest at a specific rate on a regular schedule until the maturity date. Some investors buy bonds primarily for this income, while other investors trade bonds to realize a profit when they sell. Types of Bonds There are many different bond issuers: U.S. corporations, the U.S. Treasury, cities and states as well as federal, state, and local government agencies. Many overseas governments and businesses also sell bonds on the U.S. market, as well as in international markets.
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Corporate Bonds Bonds are major sources of corporate borrowing. Debentures, the most common type of corporate bond, are backed by the general credit of the corporation, while asset-backed bonds are backed by specific corporate assets, such as property or equipment. Municipal Bonds Millions of bonds have been issued by state and local governments. General obligation bonds are backed by the full faith and credit of the issuer, and revenue bonds by the income generated by the particular project being financed. Agency Bonds
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This note was uploaded on 02/10/2011 for the course FIN 300 taught by Professor Staff during the Spring '08 term at University of Illinois, Urbana Champaign.

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