Five Things You Must Know About Bond Pricing

Bonds (and fixed-income investments in general) are too often overlooked by most investors as viable alternatives to stocks . Why is that the case?

Here are a few reasons that I think generate a general disdain for this asset class :

• Bonds offer little instant gratification to investors.
• Bonds are seen as "boring." In other words, there is no "story" to tell. It is more sexy to discuss your purchase of Baidu BIDU than the "5.25% General Electric GE of 2010" (a GE bond paying a 5.25% annual interest rate that will mature in 2010) in your portfolio .
• Bonds are traded in dealer markets and as such receive little or no media attention.
• Bond pricing (see valuation ) is far less transparent that stock pricing.

Individual investors can overcome this last reason with some basic terminology and a calculator. This installment of The Finance Professor will look at the five things you need to know about how bonds are priced.

1. What Bonds Are

Bonds are created when a corporation or government borrows money today in exchange for the promise to repay the money, with interest, in the future. These bonds represent an obligation on the part of the borrower (debtor ) to that of the lender (creditor ). Thus, bonds have a series of future cash flows that must be priced to arrive at a total price for the bond.

2. Types of Bond Issuers

Bonds are issued by a multitude of borrowers (issuers ). Before you can price a bond it is important to understand the category of bond that you are looking at. The following is a list of the most common types of bonds that you might encounter.