Generally bonds have a face value of $1,000. Let's say we buy a bond today that pays 2% annually (called the coupon, because it is paid regularly and in the old days the bond holder would redeem their coupon every year to collect their interest). Next year, the Fed raises rates and now the going rate is 3% for a bond of this risk. Our bond is no longer worth $1,000 because a bond buyer can buy a new bond that pays 3% instead of the 2% ours does. So if we want to sell this bond before the term is up (at the end of the term the company will give us $1,000 if we want to hold it that long at only 2%) we will get something less than $1,000 for it.
Many people falsely assume that bonds are "safe" but they are not. The previous example shows why. And if stock traders are a bunch of ruthless sharks, bond traders are killer whales that eat sharks for breakfast. The only way for an average Joe to make money on bonds is to buy indexed bond funds or buy and hold bonds for the term.
It is not much different from a loan. A bond is basically you loaning a company/government money, where they (usually) promise to pay you back with interest. Interest payments are generally made semi-annually while the principal is paid back in full at the end of the bond term.
The bonds can be traded/sold to others. For example, I have a $1000 bond that pays 10% annual interest semi-annually. I've had this bond for 3 years which means the company has paid me $300 in interest. The company still owes me $700 in interest as well as the $1000 principal at the end of 10 years. However, I want my money now - so I decide to sell it. People will value my bond based on some sort of Net Present Value (money today is more valuable than money tomorrow).
A bond market is where people buy/sell bonds.
Bonds are less risky than stocks because unlike stocks, the value of bonds change only with inflation, while stocks fluctuate with business activities (also including inflation). The price of a bond is determined by multiple factors. The biggest factors are the interest rate, life of the bond, and risk of the company (from going bankrupt).
Usually it goes something like this. "Hey - give me $1000. I will pay you back in 5 years. I will also pay you an additional $500 over the course of 5 years ($1500 total). Deal or no deal?"
There may also be adjustments to the price of a bond, but I'm not going to get into that.
So essentially a bond is a loan, for example $1000 dollars at 10% interest for 5 years, right? So then how is it different from a loan from a bank? I just don't get how it works: you buy a piece of paper for a thousand bucks, then the person you bought it from gives you 10% of that each of the five years then it expires and you pay back the full 1,000 dollars as well?
Why/how do people "trade" bonds? Is it more or less risky than stocks, if it is less risky then doesn't it offer less of a reward? If so then how do hedge funds make so much money, don't they just buy a sell bonds?what determines the price of a bond.
As you can see I know almost nothing.
