Bond Fundamentals

A bond is an investment security representing indebtedness and issued by governments or corporations. Bonds are usually issued in denominations of $1,000 and multiples thereof. The issuer contracts to pay the holder a stipulated rate of interest on specific dates over a stated period of time. At the end of this time the issuer agrees to repay the principal amount against surrender of the bond certificate.

Bond Terminology

Par (Face Value), Discount and Premium.
A $1,000 bond purchased for $1,000 is said to have been bought “at Par” or “Face Value”. A bond purchased at less than par is said to have been bought at a “Discount” and, if purchased at more than par, is said to have been bought at a “Premium”.

Maturity Date

The Maturity Date is the date when the issuer of the bond repays the holder the face value of the bond.

Term

The Term is the time remaining to maturity.

Coupon

The Coupon is the amount of interest that the issuer of the bond is obligated to pay the holder, and is usually expressed as a percentage of par value.

Current Yield vs. Yield to Maturity

The Current Yield is the coupon rate of interest divided by the market price. For example, a bond selling for $1000 with a 10% coupon offers a current yield of 10% (the interest would be $100, which is 10% of $1000). If that same bond were selling for $500, however, it would offer a 20% current yield (i.e. the interest would still be $100 which is 20% of the $500 market price). In contrast, the Yield to Maturity (YTM) takes into account the total annual interest payments, the purchase price, the redemption value, and the amount of time remaining until maturity. In the case of a bond trading at a discount, YTM is higher than the Current Yield. The reverse is true for a bond trading at a premium with the YTM lower than both Current and Coupon Yields.

Accrued Interest

Accrued Interest is the amount of interest which has accumulated from the last interest payment date to the date of settlement. When an investor buys a bond he/she pays the seller the accrued interest which they get back on the next interest payment date.

Market Price

The Market Price is the price at which you can buy or sell a bond in the marketplace. The price is determined by the prevailing level of interest rates, the credit worthiness of the issuer, the amount of interest (coupon) that the bond pays, and the term remaining to maturity.