The most stable form of investment are bonds. In today’s most fluctuating stock market, investment plays an important role in everyone’s life. Though many are unaware of the benefits and risks of owning bonds, not many even know how does bonds work.

Bonds are investments in which a person lends money to a corporation, company or a government entity in exchange. In return, the lender receives a certain interest for the amount of money lend at specific time intervals. Some of the bonds have benefits of saving taxes at either federal or state level.

Bonds work inversely in ratio of the credit worthiness of the issuer. The better the credit rating of the bonds the lesser the interest rate paid to the lender and vice-versa. Most of the bonds have a certain par value allocated to them. If the bonds are sold at a lower value than the par then it has been sold at a discount whereas if they are sold at higher value than par then they are sold at premium. Usually bonds are sold to fund huge projects like hospitals, facilities or other utilities.

It is important to understand and relate the risk involved in investing in bonds. Though it is calculated and looks simple when we say that for example, we buy bonds worth $100,000 for a company with good credit rating and get 6% interest annually for fixed number of years. It is obvious that you will receive $ 6000 every year as interest amount which can be either re-invested or can be used for other expenses. At the end of the term, you will still receive the entire amount of $100,000 back. Does that sound simple enough? However there are risks involved in this and what can they be like? Is it important to evolve them or just overlook knowing that the returns are lump sum?

Bonds completely depend on the credit risk. In simple terms the bonds are valid only as long as the company who issued them can pay the interest levied and the par value back to the lender or investor. For example it works exactly like any loan taken from the bank wherein there is a risk and always a question whether the loan will be paid back or not which again depends on the credit worthiness of the debtor.

The other thing which can affect the bonds value is the inflation. Well inflation in simple words would be the increase in the costs whereas there is a decrease in the currency value. The $1 which can buy certain thing this year might not be able to buy the same thing for same value next year. On an average the inflation rate has been 3-4% in last 50 years trend. Similarly, if the earning is of 6% and inflation of 3% then our primary investment doesn’t show any signs of increasing as in 2 years the value for that money reduces. Though bonds are considered to be the best investment and can get good income during retirement, however over time it can lose its value to purchase other things or maintain the cost of living. It is always beneficial to know the risks involved before making any form of investments.