Bonds for Dummies

A financial instrument used to raise debt by issuing an Security (a Bond) to interested lenders (investors), promising to return the Principal at maturity (completion of tenure of the Bond) and Interest payments at fixed intervals at a known interest-rate is called a Bond.

A Bond is a fixed-income security because it is structured to guarantee a fixed rate of return to the lender (investor) unlike Shares (also known as Equity).
Equity between an investor and an issuer is designed to share the risks of downside as well as reap the benefits of upside in the profits of an organisation. The return(%) on a Bond does not change (increase or decrease) with the changing profits of the issuing organisation. Thus, the significant difference between a Bond and a Share is the risk-sharing formula between the issuer and the investor. Shares require a greater risk-appetite on the part of an investor as the Principal invested is not guaranteed to be returned.

Therefore, Bonds are considered safe & conservative investment strategies with a rate of return (expressed in %), marginally more than the risk-free rate, that is offered by Government Treasuries and similar Soverign Bonds issued by the Government.

Junk Bonds

Another category of Bonds that is floated by organisations which are in dire requirement of funds for recapitalisation / operation is Junk Bonds. The reason these bonds are referred to as "Junk" is, because the credit rating of these issuing organisations is very low. These are companies which cannot undertake the IPO route for floating shares in the Primary market but are in a serious cash-crunch. Owing to such reasons, these companies have to offer a higher rate of return than safer bonds of AAA-rated organisations because of the higher risk perception. The buyers of such Bonds are those who are interested in the higher rate of return at relatively low prices and those who believe that a managerial turnaround is likely to bring these issuing companies back on their feet.