A bond is similar to a certificate of deposit (CD). With a five-year CD, for example, a bank agrees to pay you a set interest rate, say, 6 percent. If all goes according to plan, at the end of five years of earning the 6 percent annual interest, you get back the principal that you originally invested.

Bonds work in a similar fashion. For example, you can purchase a bond, scheduled to mature five years from now, that is issued by a company such as the retailing behemoth Wal-Mart. A Wal-Mart five-year bond may pay you 7 percent. As long as Wal-Mart doesn't have a financial catastrophe, after five years of receiving interest payments on the bond, Wal-Mart returns your original investment to you. So, in effect, you're loaning your money to Wal-Mart (instead of the bank when you deposit money in a bank account).

The worst that can happen to your bond investment is that Wal-Mart's business goes into a tailspin and the company ends up in financial ruin (bankruptcy). If that happens, you may lose all of your original investment and miss out on some of the expected interest.


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