SPEAKER: A bond is an IOU between an investor and the bond issuer. The investor lends the bond issuer a set sum of money in exchange for a promise to pay back the lump sum at a pre-agreed date in the future and regular interest payments throughout the term of the loan.
Bond issuers can be companies or governments. Generally the less financially stable the bond issuer the greater the interest payment – for example the US government would pay a smaller rate of interest than a small company in a developing economy.
If you buy the bond at the date of issue and hold it for the duration of the loan agreement the interest rate is called a coupon.
Much like shares, bonds can be traded between investors. The bond issuer remains the same, but the bond is transferred to a new owner who is then paid both the interest and, at the end of the term, the lump sum.
The price of a bond is determined by the demand. While the coupon payment is a set amount of cash, because the price of the bond fluctuates in the open market, so does the yield when expressed as a percentage.
The animation in this video was created by Morningstar video producer Roberto Iacurci
