When you buy bonds you are acting like a bank. You are buying the debts of an organization because a bond is like an ‘I Owe You’. A bond is a piece of paper explaining the size and conditions of the debt, the time period the interest rate etc. When you buy a municipal or ‘muni’ bond, you are lending money to a city or municipality. When you buy a treasury or ‘T’ bill you are lending money to the government.
On the payback side the city or government that issues the bond is promising to pay a stated rate of interest for the term of the bond and to payback the money value of the bond at the end of the term. It is the way the government raises money to do all the things it need to do such as build and runs schools or hospitals.
How to buy bonds? The majority of bonds are traded in what is called the over-the-counter (OTC) market. Some corporate bonds are also traded on the NY Stock Exchange as well. The OTC market is made up of hundreds of companies that deal in securities and banks that trade bonds. It isn’t done hand to hand but usually by phone or Internet. Some companies keep a stock of bonds and trade them as their own business while others act as middlemen in trading with other dealers on behalf of other clients.
Bonds are one of the safest forms of investment but that is not to say that there is no risk involved. Even governments and cities can go bankrupt. If you wish to take advantage of a new bond issue, you should seek out a professional independent advisor who will give you guidance on the offering statement or prospectus for the bond in question. The offering statement is the official terms and conditions of the bonds. It will also layout the risks that investors must take into account before investing.
There is also a secondary market in bonds. You can buy these bonds in the same place and in the same way as new bonds but they are what you might call ‘second hand’. People and organizations hold bonds for a while and for whatever reason want cash for them, even though they have been previously issued.
Bonds traded over-the-counter market are generally in $5,000 denominations while the secondary market bond prices are broken down into in $100 lots. So for example a bond offered for say 95 refers to one that is priced at $98 for a $100 lot, or at a 5% discount. Bond prices will always reflect the dealer’s costs and profit margin.