A company or even a government entity sells a bond for a certain amount of money. At a specified date of maturity, the selling party is to pay back the initial investor the price of the bond plus interest. Not all bonds pay interest, but all bonds must pay back the principal.
Buying a bond does not give the buyer an interest or stock in the company, but in the event of a company collapse, the person holding a bond is considered a creditor and will be among the first to be paid off if the company still has assets to sell. A person holding a stock in the company can only reclaim the market value of the stock.
Bonds can be issued for maturity from a 1-year to a 30-year period.
When a corporation sells a bond, it is known as a corporate bond. A corporate bond usually pays a higher interest rate, also known as “yield,” than a regular bond.
If you are buying a bond from a start-up company that hasn’t shown a particular potential for generating substantial profits, you are taking a high risk. These bonds, also known as “junk bonds,” offer a higher yield than a bond purchased from a company such as Chase Manhattan, which is known as a “Blue Chip” company. A blue chip bond would produce a lower yield, but would also be at a lower risk of defaulting.
Since bond holders must be paid off before stock holders, bonds are a less risky investment.
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