What is a Bond ?
A bond is one of the fixed income investment products that represents a loan given to a borrower by the investors. The investors get interest income in return for the money they lent. It includes details of the loan like the date when the principal payment is due, the interest and the terms of interest payments.
Companies sell bonds to finance ongoing operations, new projects or acquisitions. Governments sell bonds for funding purposes, and also to supplement revenue from taxes.
It is a liability for the issuer (usually a government or company), and an asset for the bondholder (usually an entity or individual investor).
TERMINOLOGY OF BONDS –
There are some important key terms that are associated with all types of bonds. These are –
- MATURITY : The bond issuing company agrees to pay back the principal amount of the bond to the bondholder on a pre-defined date. This is called the bond maturity date. Once the principal amount is returned, the bondholder stops receiving the interest payments as well.
- PAR VALUE : Par value is the amount of money that will be returned to the bondholder at the maturity date. It is also known as face value of the bond.
- YIELD : It refers to the rate of return on the bond. While coupon is fixed, yield is variable and depends on a bond’s price in the secondary market and other factors. It can be expressed as current yield, yield to maturity and yield to call.
- MARKET VALUE : The market value of a bond is the value at which the bond is currently being bought and sold in the market which can either be at premium or discount to the face value.
- COUPON : A coupon payment is the amount of annual interest that will be paid to the bondholder on an annual basis. The coupon payment per bond unit is :
Coupon Payment = Face Value of Bond X Coupon Rate of the Bond in %
This amount can be paid either monthly, quarterly, annually or semi annually until maturity.
- BOND DURATION : Duration measures the sensitivity of a bond‘s price to the interest rate changes. It is not an indicator of the length of time until maturity.
- CURRENT YIELD : Current yield is the coupon (interest) divided by the current market price of the bond, which maybe more or less than the par value.
Thus, in simple words bonds are investment securities where an investor lends money to a company or a government for a set period of time, in exchange for regular interest payments.