Bond Basics

If you've ever wondered what the "long bond" and "zero coupon bonds" are, wonder no more.

Bonds come with a variety of maturity periods. The long bond is the U.S. government's 30-year bond. Its yield is often cited by the media when interest rates are discussed. Treasury notes are shorter-term, maturing in two, five, or 10 years. Treasury bills (or T-bills) mature in 13, 26, or 52 weeks. The minimum purchase amount for most of these instruments is $1,000.

Most people are familiar with zero coupon bonds in the form of U.S. Savings Bonds. You buy them at a discount to the face value, hold them for a specified time period, then cash them in at face value. In a nutshell, that's how zero coupon bonds (or "zeroes") work.

Imagine a regular 5% $10,000 bond, where you lend $10,000 to a company or government. You receive interest payments of 5% per year until the bond matures, when you get your $10,000 back. (You used to have to send in coupons to get these payments.)

With a zero coupon bond, you don't receive any interest payments, but the amount you lend is smaller than the amount you'll receive at maturity. Thus, a zero coupon bond could pay you the equivalent of 5% per year by having you pay $6,139 today to receive $10,000 in 10 years.

Bonds typically carry riskiness ratings. Companies that rate bonds include Motley Fool Stock Advisor pick Moody's (NYSE: MCO  ) and Standard & Poor's, a division of McGraw-Hill (NYSE: MHP  ) .

Learn more about bonds in these articles by S. J. Caplan:

And in this article by Dan Caplinger:

Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article.


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