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Bank accounts
aren't the only way your money can earn interest. Bonds are a
way of loaning money to a government, government agency or
corporation. Just like a loan, the organizations that issue
bonds agree to pay interest as a condition for using your
money. When you buy a bond, your purchase price is considered
the loan's principal. The terms of the bond tell you when
you'll get your money back, which is known as the bond's
maturity date, and how much interest you'll receive, which is
known as the coupon rate.
Let's say you buy
a $1,000 bond whose terms included 5% simple interest, payable
yearly, with the bond due in five years. You'd receive $50
each year - paid semiannually for five years - and your
original $1,000 back at the end of those five years.
There are no
guarantees with bonds. There are a number of risks associated
with bonds, including the risk that the issuer will not be
able to make regular interest payments or pay the principal
when it's due. However, many bonds are rated by agencies such
as Moody's and Standard and Poor's. These agencies consider
the financial health of the issuer and give it a grade,
telling you how likely they think it is that a particular
government or corporation will default - or fail to pay on
your loan. Higher-risk issuers usually pay higher interest
rates on their bonds than do lower-risk issuers. Here is the
system Moody's and Standard and Poor's use to rate municipal
(or government) and corporate bonds fromBarron's Dictionary
of Finance and Investment Terms.1
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Moody's |
Standard and Poor's |
Highest quality |
Aaa |
AAA |
High quality |
Aa |
AA |
Upper medium grade |
A |
A |
Medium grade |
Baa |
BBB |
Predominately speculative |
Ba |
BB |
Speculative, low grade |
B |
B |
Poor to default |
Caa |
CCC |
Highest speculation |
Ca |
CC |
Lowest quality |
C |
C |
1 Downes,
John and Jordan Elliot Goodman, eds. Dictionary
of Finance and Investment Terms. 5th edition. Hauppauge,
NY: Barron's Educational Series, Inc., 1998.
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