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In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) and/or to repay the principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals.
Bonds are issued by public authorities, credit institutions, companies and supranational institutions in the primary markets. The most common process of issuing bonds is through underwriting. In underwriting, one or more securities firms or banks, forming a syndicate, buy an entire issue of bonds from an issuer and re-sell them to investors. The security firm takes the risk of being unable to sell on the issue to end investors.
Bonds have a number of characteristics of which you need to be aware. AII of these factors play a role in determining the value of a bond.
Coupon (The Interest Rate)
The coupon is the amount the bondholder will receive as interest payments. It's called a "coupon" because sometimes there are physical coupons on the bond that you tear off and redeem for interest. However, this was more common in the past. Nowadays, records are more likely to be kept electronically.
As previously mentioned, most bonds pay interest every six months, but it's possible for them to pay monthly, quarterly or annually. The coupon is expressed as a percentage of the par value.
The maturity date is the date in the future on which the investor's principal will be repaid. As long as all payments have been made, the issuer has no more obligation to the bond holders after the maturity date. The length of time until the maturity date is often referred to as the term or tenor or maturity of a bond. There are three groups of bond maturities:
short term (bills): maturities up to one year;
medium term (notes): maturities between one and ten years;
long ter m (bonds): maturities greater than ten years
A bond that matures in one year is much more predictable and thus less risky than a bond that matures in 20 years. Therefore, in general, the longer the time to maturity, the higher the interest rate. Also, all things being equal, a longer term bond will fluctuate more than a shorter term bond.
The issuer of a bond is a crucial factor to consider, as the issuer's stability is your main assurance of getting paid back.
For example, the U.S. government is far more secure than any corporation. Its default risk (the chance of the debt not being paid back) is extremely small - so small that U.S. government securities are known as risk-free assets. The reason behind this is that a government will always be able to bring in future revenue through taxation. A company, on the other hand, must continue to make profits, which is far from guaranteed. This added risk means corporale bonds must offer a higher yield in order to entice investors - this is the risk/return tradeoff in action.
Types of bonds
Fixed rate bonds have a coupon that remains constant throughout the life of the bond.
Floating rate notes (FRNs) have a variable coupon that is linked to a reference rate of interest, such as LIBOR or Euribor.
Inflation linked bonds. in which the principal amount and the interest payments are indexed to inflation. The interest rate is normally lower than for fixed rate bonds with a comparable maturity.
Asset-backed securities are bonds whose interest and principal payments are backed by underlying cash flows from other assets.
Types of bonds
Subordinated bonds are those that have a lower priority than other bonds of the issuer in case of l iquidation.
Perpetua l bonds are also often called perpetuities or P erps'. They have no maturity date.
Bearer bond is an official certificate issued without a named holder. In other words, the person who has the paper certificate can claim the value of the bond. Often they are registered by a number to prevent counterfeiting, but may be traded like cash. Bearer bonds are very risky because they can be lost or stolen.
War bond is a bond issued by a country to fund a war.
How To Read A Bond Table Colu m n 1: Issuer - This is the company, state (or province) or country that is issuing the bond. Column 2: Coupon - The coupon refers to the fixed interest rate that the issuer pays to the lender. Column 3: Maturity Date - This is the date on which the borrower will repay the investors their principal. Typically, only the last two digits of the year are quoted: 25 means 2025, 04 is 2004, etc. Column 4: Bid Price - This is the price someone is willing to pay for the bond. It is quoted in relation to 100, no matter what the par value is. Think of the bid price as a percentage: a bond with a bid of 93 is trading at 93% of its par value. Column 5: Yield - The yield indicates annual return until the bond matures. Usually, this is the yield to maturity, not current yield.
Bonds are just like lOUs. Buying a bond means you are lending out your money.
Bonds are also called f i xed-income securities because the cash flow from them is fixed.
The issuers of bonds are governments and corporations.
A bond is characterized by its face value, coupon rate, maturity and issuer.
Yield is the rate of return you get on a bond.
When price goes up, yield goes down, and vice versa.
When interest rates rise, the price of bonds in the market falls, and vice versa.
Bills, notes and bonds are all f i xed-income securities classified by maturity.
Government bonds are the safest bonds, followed by municipal bonds, and then corporate bonds.
Bonds are not risk free. It's always possible - especially in the case of corporate bonds - for the borrower to default on the debt payments.
Bond- are debt and are issued for a period of more than one year.
Underwriting- t he process of placing a new issue with investors .
Syndicate - a group of banks that acts jointly, on a temporary basis, to loan money in a bank credit (syndicated credit) or to underwrite a new issue of bonds .
Coupon - t he annual interest paid on a debt security.
Maturity- t he date on which payment of a financial obligation is due.
Issuer- a n organization that is selling or has sold its securities to the public.
Bid Price- t his is the quoted bid , or the highest price an investor is willing to pay to buy a security .
Yield - t he percentage return paid on a stock in the form of dividends , or the effective rate of interest paid on a bond or note .
IOU - "I owe you.“ An IOU in the business community is actually a legally binding agreement between a borrower and a lender.