Chapter 13: Bonds and Bond Funds
Most individual investors include bonds as part of their investment portfolios. Typically, bonds are the “safer” (or less risky) part of the portfolio. Essentially, bonds are loans to the government or a corporation, which are then paid back to the lender or bondholder over time. To simplify, a buyer of a bond has a contractual right to interest payments on a regular basis, and then the return of the principal. An exception would be a zero coupon bond (zeros), which has no coupon. Zeros are purchased at a discount to the par or face value. Upon maturity, the bonds are worth par or 100. The difference between 100 and the purchase price is your return. By purchasing bonds from highly-reliable issuers, a bondholder can have a very safe stream of income in the future.
Bondholders are protected. Usually, if a corporation goes bankrupt, bank debt is paid first, then secured bondholders, then unsecured bondholders. Only after those obligations are paid will excess funds be distributed to the holders of preferred and finally common stock.