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How Bonds Work And Make You Money

What is a bond and how can it help to make you money and grow wealth? The good news is, bonds are not very complicated and are very comparable to normal loans.

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Transcript:

What is a bond, how does a bond actually work?I'm Clay, let me explain.(intense music)To start things off, let's just put bond aside,don't even worry about bond anymore,get that word out of your mind.Is it out of your mind?Okay, cool.So what I wanna focus on right nowis just a loan.What is a loan, how does a loan work?If you know all this, just bear with me.So a loan in this situation,let's just say is for a house,so let's put some windows there,that kinda looks like a face, but that's okay.Pretend that that is a house,and this house is for sale for $100,000.So there's a sign in the yard, there we go.For sale, $100,000, that is the cost of that house.And over here you have Joy,and Joy sees the house and she's like,I like that house, I would like to purchase that house.So what does Joy have to do?Because she doesn't have $100,000.Well Joy is gonna do what?She's gonna hop over hereand come talk to the trusty bank,and she's gonna say, you know bank,I see this house, I like this house,the house costs $10,000,and she's gonna come up with an agreement with them,and down here the bank is gonna say,hey, you know what?Good.Meaning, we agree, we've dones some analysis,and that looks like a good deal for us.Meaning your credit checks out.So they're gonna do some research,and for them, it seems like a good deal,so what are they gonna do?Well, they're gonna make an agreement with Joy.So down here we'll talk about the agreement.And part of that agreement is going to be the number,which would be $100,000 known as the principal.Down here you would need 30 years,so that would just be the length of the loan.I'm trying to think, yeah, 30 years is pretty standard.Usually in the mortgage market 30 years or 15 years,but all of this point here being that is the length.And then down here, and I'm just making this up,let's say 5.5%, and that would be the interest rate,meaning that is how the bank is gonna be making their money.So that is the agreement that is madebetween Joy and the bank for the purchase of this house.That would be a mortgage.If you're not sure what a mortgage is,hey, now you understand the basics of a mortgageand how that works.A mortgage payment is just based off ofand calculated from those numbers down there,which is part of the agreement.But now let's focus on what a bond is.Well, a bond really is the exact same thing,there's just different terms and suchthat are thrown into the mix.So let me change up the colors here.So instead of Joy over herewanting or needing something,it's gonna be more so like,so we'll put a bunch of windows here for some,just pretend those are like skyscrapers.So it could be some sort of company, that what?That is going to need money.'Cause Joy needed $100,000,but sometimes companies need money.Who else needs money?Well,these are supposed to be some pillars,good old Uncle Sam.The government sometimes needs money.And there's other different ways,there's other different entities,but the two main ones are gonna be governmentand then companies need money,just like Joy needed $100,000.So what are they gonna do?Well, they are going to actually offer up,instead of loans, now look at it as bonds.They're gonna say to, hey, the public,to anybody that's willing to listen, we need money.And in this situation let's just saythat they wanna collect $100,000 total,but they're willing to do it in pieces,they're willing to do it,not necessarily looking for one personto give 'em $100,000,but they're offering multiple bondsin order to raise the $100,000.So once again, they need $100,000 in total,so what they're gonna do is like I said,just offer that up to people.So now all the sudden Joy is no longer over here,she's actually over here.Or in other words,Joy is essentially playing the role of the bank,because the companies or the governmentis going to offer up and try to make an agreement with Joyto get her to give them some money,to give them what?A loan, it's just not called a loan,it's just called a bond.A bond is the mechanism that is being used here.So from that point of view,let's just say that a bunch of things get thrown out,a bunch of things get thrown out.And then it finally says, ah, ah, I like that, that is good,so much so that I accept this agreement.Now the agreement down here, same exact thing,just a little bit different terms.So like I said, in this situation they need $100,000 total,but Joy doesn't have $100,000,but she's willing to, you know what,I'm gonna give in this situation $1,000.So $1,000 is what they're offeringand what Joy's gonna give them,and that is what's known as the face value.So the face value of this bond of what is the loan,$1,000.The next part of it is gonna benot the length in terms of a mortgage length,but as far as a maturity date.So in other words, did you see our special lighting effects?Spent top dollar for those.The maturity date here is gonna be,that's part of the bond.And then finally down here,they're not gonna call it an interest rate,they're gonna call it a coupon rate.And those are the main functions,those are the main parts of a bond.Again, the face value is reallyjust the principle of the loan.The maturity date is really just the length of the loan,and the coupon rate is reallyjust the interest rate of the loan.I don't know why they have to change stuff around,but I guess that's the markets for you.So those are the three different dynamicsof what a bond is.It's literally just like a loan.But maybe you're thinking, okay Clay,how does the math actually work up?Why did Joy say good?What number was she looking atthat made her agree to make the agreementwith these different dynamics of it?So let's take a look at the math.I have assigned some numbers and tried to color code it,so we've already had $1,000,and that is the face value.We have ten and that is the maturity date right up here,and then we have the coupon rate, which 4% right there,so coupon of 4%.And the one thing to keep in mind is it's paid annually,and I'll show you what that meanswhen something is paid annually.So the math is nothing complicated at all,if you know how to do some multiplication and some division,you'll be good to go.So the first part that you're gonna dois just figure out, well, how much per year?Annually, that means per year.How much per year is this bond actually going to pay?So in order to do that, you have to take the face value,which is $1,000, and you multiply that by the coupon rate,and that is going to give you,what color should I, let's just go back to the black,that's gonna give you $40.So in kind of jargon if you will,that's going to bethe coupon rateper year.So this bond is gonna give you $40 per year,and that is why hopping back up here,these are called fixed income,because you know how much you're going to get.Whereas let's say a stock for example,stocks are fluctuating all over the place.You could lose money, you could make money,you just don't know.But with fixed income you can do math and know that,okay, based off of the agreement that Joy madeshe knows she's gonna get $40 per year.And sometimes, and this will also vary,but how is this paid out?Well, in several situations this would be knownas the payment schedule,and all the payment schedule meansis hey, you know what?Well it's a schedule of payments.So when is this going to be paid out?And in this situation let's just say it's semi-annually.Semi just meaning two.So two times a year Joy's gonna get a payment.So we already know that the per year rate is $40,so all you do here is just divide that by two,and that's telling you that twice every yearjoy's gonna get a payment of $20.Math very straightforward, nothing complicated at all.You're just taking the face value,multiplying it by the coupon rate,and that's gonna give you a number,and then based off of the payment scheduleand how the bond is actually structured,again that's gonna vary,but you would know all that going in,hence that's part of the fixed income,because you know all these different parts of the agreement,you would be able to calculate out the remainder of that,which again, yes you get $40 per year,but because the payment schedule states it's semi-annually,meaning two, then each one of those is going to be $20.Maybe that's gonna be quarterly, quarterly meaning four.So in this situation you would just divide that by four,and now you would know that you wouldbe getting $10 four times per year.But that is what a bond is, that is how a bond works.It's jus a loan, but instead of, you basically,the person, you get to play the role of the bank,and you get to determine,do you like the agreement or don't you?And if you do, you can say, good, I accept,and you're gonna have all the information neededfor you to know how much exactlyyou would be getting paid every year,or however it works.And then for how long too, because in this situation,Joy is, again, gonna be making $40 per yearfor the next 10 years,because that's when the bond matures.Mature meaning it's over, the loan agreement,and the loan has been met,and both parties go their separate ways.So that is what a bond is.If there are any other questionsor you have suggestions for more Clay explained videos,leave those down below.If you're out there trading a loan currently,and maybe are in the market looking for a community to jointo assist you in your trading,or to just help you, give you another set of eyeballs,then I do have a private trading communitywhere you can trade alongside meand other experienced traders.So what you see popping up on the screen right nowis both an information link,so if you click on the inner circle one,that is going to take you to the pagewhere I explain all the detailsof what exactly come with the community,both the chat room and the newsletter,and then the other image that has popped upis a behind the scenes tourwhere you can see exactly what is going to be containedwithin the community.I take you through, like I said,a behind the scenes tour of everything,and that way you'll know preciselywhat you are getting when you join.So definitely check that stuff outif you are interested and thinkingabout wanting to join a community.And let me know if you have any questions.

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