Basic Bonds Terminologies
In simple words, a bond is a promise to pay a specified amount of interest over time and to repay principal at maturity. The bonds are essential financial instruments and before dealing in bonds it is good idea to teach yourself some basics about bond principles.
Principal (also known as par value, par, or face value) represents the dollar amount of the bond at the time it is issued. Par value is the amount the lender is repaid when the bond matures. Most bonds have a face value of $ 1 ,000.
Bond Interest/Coupon Rate
The rate of interest shown on the face of bond is referred to as the coupon rate. A bond’s coupon rate is generally comparable to what other bonds being issued at that time are paying.
A bond rating allows an investor to assess the general risks of buying a bond before making the actual purchase. Bond issues are often rated by credit agencies based on numerous factors such as financial status of person buying the bond, future financial plans and prospects and ability to secure the issue of bond.
Bonds typically have a stated maturity. This is the final date on which the bond debt becomes due for payment andthe obligation is settled. Face or par value is the value ofa bond at maturity.
A bond is often bought and sold during its lifetime. Some types ofbonds may be paid back (called) at an earlier date. At maturity, the bondholder receives the par value of the bond.
A bond’s coupon rate never changes, but inflation and changes in market interest rates influence the value of a bond.
Yields and Return
Current yield is the annual rate of return expressed as a percentage of the annual interest payment relative to the current price of the bond. A ten-year $ 1, 000 bond paying 5% interest per annum earns $50 per year for ten years. If the current price of the bond is $1,250, the current yield would be about 4% ($50/$1,250). The current yield is the same as the interest rate if the current price of the bond is at par.
Bond Ranking and Liquidation
Bonds may be classified as equal, senior, or subordinated in relation to other debt obligations. These rankings affect priority in liquidation.