Abstract
Corporations finance their operations by selling stock and bonds. Owning a share of stock means partial ownership of the company. Stockholders share in both the profits and losses of the company. Owning a bond is different. When you buy a bond you are loaning money to the corporation, though bonds, unlike loans, are tradeable. The corporation is obligated to pay back the principal and to pay interest as stipulated by the bond. The bond owner receives a fixed stream of income, unless the corporation defaults on the bond. For this reason, bonds are called “fixed income” securities.
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Notes
- 1.
Treasury bills have maturities of 1 year or less, Treasury notes have maturities from 1 to 10 years, and Treasury bonds have maturities from 10 to 30 years.
- 2.
Fortunately for investors, a rate change as large as going from 6 % to 7 % is rare on a 20-year bond.
- 3.
Trivially, a bond that must be paid back immediately is worth exactly its par value.
- 4.
See Dowd (1998).
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Ruppert, D., Matteson, D.S. (2015). Fixed Income Securities. In: Statistics and Data Analysis for Financial Engineering. Springer Texts in Statistics. Springer, New York, NY. https://doi.org/10.1007/978-1-4939-2614-5_3
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