Risk Profile

You know that song "Hello?" by Adele? You've heard it before—like 8,000 times.

"Hellooo…how arrre you…"

So think of the you today, wondering whether you should loan money to the you of 10 years ago. Hello? Would you? How much? On what terms? What details would you have wanted to glean before you wrote the check for your hard earned money to risk being fully lost?

Dialing it back: here are the key vocab words you must know—the key components to a bond:

The principal is the base amount of a bond loan: the dollar amount that is loaned before interest and fees or commissions or taxes or anything else. In the world of corporate bonds, and most government bonds, the base amount is usually in multiples of $1,000. And for larger accounts, $5,000. These are called bond denominations. You know, like…denomination for best bond in a short film category goes to…the T-Bill.

The principal in a mortgage style bond is the amount the bank is loaning you so you can buy your 3-bedroom, picket fenced quarter-acre with basement dungeon dream home. If you put $100,000 down and borrowed $400,000 as your mortgage from the bank to pay $500,000 for the dream home of your life, your loan principal is $400,000.

In most bond scenarios, the principal can be—and is—bought and sold just like any other security. So let's say the older you realizes that you take way too much risk in life you followed your dreams (tried to become a rock star), rather than listening to your nightmares (age 40, homeless, and broke). So the older you sells that bond to someone else who doesn't mind your maniacal focus on head-banging metal band practice. Or at least, unlike the older you, doesn't view that as a fundamental risk in them paying back the money they borrowed.

Bonds are typically issued in $1,000 base units—that $1,000 is their par or face value. But they are quoted in units of 100. That is, a bond unit selling for $1,025.00 would be quoted as 102.5, or one-oh-two-and-a-half. And when you buy the bond, you pay 103 cents on the dollar; the seller of the bond gets 102.5 cents on the collar. And to get really technical, bonds are usually quoted as a spread. That is, 102.5 x 103, which means that, if you are a buyer of the bond, you pay 103 cents on the dollar; if you are a seller of the bond, you'd get 102.5 cents on the dollar. The spread (which pays the person making the market in the bonds, or the broker) is: $1,030.00 – $1,025.00 = $5.

So when you do buy a bond, you’ll buy it in one of two ways. In the olden days, there were a lot of bearer bonds, meaning the bearer, or person who had the bond in their possession, owned it. Basically, back then, you could carry around bonds just like they were cash, and there was no trail...in the same way there’s really no trail on a $20 bill you just downloaded from a Versateller ATM robot. But because bearer bonds are really not the best thing to be carrying around folded in your wallet, the trend quickly became to issue new bonds as registered, mainly so that they could be held electronically, and save the murder of millions of trees and/or sheep.

Today, most bonds don’t even carry a paper attribute. Rather, the buyer gets an email with a bond registration number, and those bonds are usually held inside of the buyer’s mutual fund or hedge fund, or if it’s a consumer buying the bond, the number just shows up in their Fidelity, Schwab, Etrade, or other online brokerage account.

So, today, bonds don't get a certificate—they are issued in book-entry form. The transfer agents just keep electronic records of the bonds in their little scriveners' ledgers. The names and addresses and data of the buyer and seller are copiously stored, but there's no subsequent paper paperwork that goes along with it. All of this is really cool to now be electronic, but back in the day, bonds were actually printed. Some of the artwork was pretty cool.

Okay, next big element of a bond is the Nominal Rate. "Nominal" means "in name." So on the face of the bond certificate, there will be a "named interest rate." On a given bond, say the nominal or "face amount" is 4.0%. So this piece of paper, backed by the company Solar City (now owned by Tesla), pays 4% interest. Let’s pretend the bond is a $1,000 unit. That means the registered owner of this bond is due to be paid $20, twice a year—or $40 a year—as interest payment.

So the quick summary: you buy a bond for $25k that pays 8% a year. The principal is 25 grand, the interest payment is 2 grand a year, or $1,000 every six months, because that’s how bonds roll. They pay interest twice a year. The nominal rate of the bond may be 8%, but if you had to pay a premium of, say, 30 grand instead of the 25 grand for that 8% paper, then you won’t actually be getting 8% return on your 30 grand. You’ll still get 2 grand a year, which is 2/30, or 6.7% return.

If you really want to feel connected with dead, bad Grandpa, you can try to find bearer bonds, which are like old, $10,000 bills...but you’ll have a whole lot more luck finding a wide selection of bonds in the registered aisle of the bond grocery store.