My parents began to teach me the importance of saving money at an early age – In fact, I received a weekly allowance of $5. While my parents encouraged me to save, all I could think of was what video game I could rent for my Nintendo 64 (Mario Party 3 or Mario Kart?).
More often than not, I did not have enough money to rent the video game and I asked my parents for a few extra dollars with the promise of paying them back in the future, an IOU (Sike!).
A promise to return a sum of money within a specific time frame is the function of a bond.
What is a Bond?
A Bond is an IOU, where YOU act as the bank.
You’re lending your money to a company, city, or government municipality with the expectation of earning interest.
What is Principal and Interest?
Let’s say you decide to purchase a bond from Apple, Inc. for $1,000. The $1,000 represents your PRINCIPAL, or your investment.
Interest the amount of money you EARN for lending your money to another party.
By purchasing a bond, you are expecting to receive your principal and interest from the entity that you lent your money to. To be clear, there is no guarantee that you will receive your original principal or interest payments (we will take more about that another time).
As illustrated above, you can earn money from holding bonds by receiving interest or selling the bond at a higher price than you originally purchased it for.