Booyah Breakdown: Bond With Bonds

Bonds also have interest-rate risk -- no surprise. Let's say you bought a bond with a 6% interest payment. But what if interest rates rise? Now there are bonds out there with 8% interest rates. So you're missing out on a higher interest payment.

That's why bonds with longer maturities, such as 10-year and 30-year bonds, have more interest-rate risk. The odds are good that interest rates will change over 10 years. But if you buy a bond that has a one-year maturity, the rates probably won't change that much during that 12-month period.

So you have to analyze two things: whether the issuer is going to be able to pay you in the end and whether your interest-rate risk is too much to handle.

Yield to the Yield

One final piece of jargon you need to be aware of: a bond's yield. In general, the yield of anything is its annual rate of return, expressed as a percentage.

So in the equities market, we look at a stock's dividend yield (check out this previous Booyah Breakdown for more on that), to see how much extra money we're going to make off the shares. The dividend yield is just the annual dividend payments divided by the stock's current share price. The higher the yield, the more money you're going to pocket.

Same is true in the bonds market. A bond's yield is essentially the value of its interest payments. So it's a good basis of comparison with other bonds.

But know that higher-yield bonds generally come with more risk. That's because the issuer knows that there's a chance he may default on the loan or that the bond's maturity is a long way off. So he pays you more -- in the form of an interest payment -- for taking a chance and helping him with his debt.

So now you've got some lingo down. Next time we'll talk about how bonds price and how their yields are determined. And then we'll tackle that infamous yield curve and discuss why it's making folks uneasy these days.

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