Typical Bond Interest Rates
A basic explanation of bond interest rates can seem simple enough at first, but a closer examination reveals more complexity in terms of how bonds work and how interest rates are set and changed than first meets the eye. Bonds consist of two parts - the principal investment, and interest paid at regular fixed intervals until the bond matures. Investing in bonds is thought to be lower in risk than investing in mutual funds, stocks, real estate, or other investment vehicles. However, investments in bonds are not without their risks, and it is important to ensure a basic understanding of all facets of bond investment, including typical bond interest rates, before beginning to participate in this form of investment option. Learn more from financial experts about how bonds work and how typical bond interest rates function before deciding whether investing bonds is the right strategy for you.
What is a Bond?
Simply put, a bond is defined as a loan made to the bond issuer. Bonds are issued by corporations and governmental agencies and entities to help fund various initiatives. There are five basic categories of bonds. Government or treasury bonds have the lowest yield but the least risk, and are used to pay off debt and fund government initiatives. Agencies like Fannie Mae and Freddie Mac use capital from issuing bonds to assist low income individuals and families with lines of credit. Municipal bonds are issued by local municipalities to fund public projects and are generally tax-exempt. Corporate bonds finance corporate activities and come with both higher risk and higher return attached. Finally, mortgage-backed loans are issued by financial institutions to fund offerings of future mortgages. The lower the risk, the higher the bond rating is, and ratings can go up to as high as AAA. The higher the risk, the lower the bond rating is, and bonds with a BB or lower rating are often referred to as "junk" or high risk bonds.
Bond Terminology
The principal of the bond, which will be returned to the investor at maturity, is called the "face value" or "par value" of the bond. The fixed interest payments that are made regularly until the bond matures are called the bond's "coupons". The "coupon rate" is the interest rate that will be paid on the principal.
Why Invest in Bonds
Bonds are a more stable investment than mutual funds or stocks, as the investor is guaranteed a return of the principal upon plus regular interest payments along the way. The interest payments are where fluctuation and risk are involved in investing in bonds.
How do Bond Interest Rates Work
Bond interest rates are set by the market, and can rise or fall as the market rises or falls. While the interest rate and the coupon rate of the bond will remain fixed from the time of purchase through to the time the bond matures, the value of the bond itself will rise or fall according to the market interest rates. This is usually not of concern to a bondholder who intends to hold their bond investments until they mature, at which time they will receive the full value of their initial investment back again.
But for bondholders who wish to sell bond investments before they mature, fluctuating interest rates may have a noticeable impact upon the sale price of the bond. As market interest rates fall, the value of the bond-in-progress rises accordingly, because new investors can now purchase the bond for less than its face value. As market interest rates rise, the value of the bond-in-progress falls with them, as investors are not willing to invest amount greater than its face value. Additionally, as market interest rates rise or fall, and the fixed coupon rate of the bond stays the same, the incentives to purchase a bond-in-progress fluctuates with them. In summary, as market interest rates rise, bond value falls, and as market interest rates fall, bond values rise. Bonds that sell before maturity while interest rates are higher than they were at time of first purchase are called "discount" bonds.
What are Typical Bond Interest Rates
While market interest rates determine bond interest rates, typical bond interest rates will be set by the issuing entity and can vary by the type of bond, the risk involved, and the face value of the bond. Issuing entities are able to set their own interest rates although the market is their guide. To find out typical bond interest rates for a specific kind of bond, contact that bond's issuing entity for more information.
