A bond is a debt instrument sold by a company or government entity to raise funds. The purchaser of a bond becomes a creditor of the bond issuer; unlike stocks, purchasing a bond does not make one an owner. If a company goes bankrupt and its assets are liquidated, bond holders get paid before stockholders.
There are three main types of bonds:
- Corporate Bonds – issued by a company to raise capital.
- Municipal Bonds – issued by a state, city, or other local government entity. Municipal bonds are often tax-free.
- Federal Bonds – issued by the Federal Government. Federal bonds are one component of the national debt.
A bond fund is a kind of investment company that invests primarily in bonds (similar to the way a mutual fund invests in stocks). They have been promoted heavily in recent years as a "safe" investment; investors, hurt by the recent market drop but wanting high returns, found them extremely attractive. This created a situation highly conducive to abuse and fraud.
With bank savings accounts paying in the range of 1%, brokers found investors eager to listen when they were selling bond funds that turned out to be junk bond funds. (A junk bond is a high-risk, high-interest corporate bond.) Many investors didn't even know that they were investing in junk bonds, because they weren't called "junk bond funds". They were called a "high yield fund" or simply a "bond fund". In this way, brokers misled investors about the nature of the investment they were pushing.
Brokers also mislead investors about the risks involved with investing in bond funds. Bond funds are promoted as having little or no risk. In reality, bonds and bond funds are subject to investment risks, including:
- Credit risk – the risk that the issuers of bonds owned by a fund may default (fail to pay the debt that they owe on the bonds that they have issued).
- Prepayment risk – the risk that the issuers of the bonds owned by a fund will prepay them when interest rates are low. Because of low interest rates, the fund may have to reinvest the proceeds in bonds with lower interest rates, reducing the fund’s rate of return.
- Interest rate risk – the risk that the market value of the bonds owned by a fund will fluctuate as interest rates go up and down. All bonds, even Federal bonds, are subject to this form of risk.
Learn more about the recent boom in bond arbitration cases here.
If you lost money in bond funds, and your broker misled you about the nature of the investment, you may be able to recover your losses. Fill out the form here and tell us a little about your situation; a member of our staff will perform a free case evaluation, with no cost or obligation to you.