Finance - Bond Basics

Bond Basics

Fixed Interest Investments Home | Bond Basics | Sovereign Bonds | Corporate Bonds | Euro Bonds

Should you decide to dive into the offshore bond market, you will be able to make more informed choices if you have a grasp of the following bond-related vocabulary, which is listed in logical - rather than alphabetical - order.

Coupon

What your financial advisor refers to as a bond's coupon is the annual interest rate you will be paid - generally on the anniversary of the day you bought the bond.

Fixed Rate Coupon

This type of coupon tells you exactly what you will get in interest that will be paid out at set intervals. These are generally considered to be a good choice for those of us who don't especially like surprises.

Floating Rate Coupon

These are bonds with adjustable interest rates. Generally, a floating rate coupon should state, in no uncertain terms, at which intervals your interest rate adjustments will be made.

Zero Coupon

This is the bargain basement as these bonds are sold at discounted prices and then paid out - to you - in a lump sum at maturity.

Maturity

This can range from one day to one hundred years - depending on the particular bond you are investing in.

Early Redemption

There are two types of early redemption. One is called "call" and the other is called "put". Basically the former has a higher interest rate and is "called" by the issuer when market interest rates dip lower than the bond's interest rates. In the latter case, we're dealing with a bond that has a lower interest rate and is "put back" to the issuer by investors when interest rates rise, thus making it more attractive to invest elsewhere.

Price

The general rule to remember when discussing bond prices is that if interest rates go down, bond prices go up, and if interest rates go up, bond prices go down.

Premium

This is when a bond that is traded for a price that is higher than its face value.


Discount

This is the term used to refer to a bond that is traded for less than its face value.

Yield

This is the most important factor to think about when comparing bonds.

Current Yield

This is the annual return on the bond and is based on its coupon rate and market price. You can calculate this by dividing the cupoun by the market price. Quite simple.

Yield to Maturity

This is not so simple to calculate, but with the help of your financial advisor, its calculation will give you the total return you can expect should you hang in there until the bond reaches security.

Credit Risk

this is the risk that the entity issuing the bond will default - i.e. leave you holding the bag either in terms of punctual interest or principle payments, or both. This is regularly rated by internationally renowned rating agencies and also by the research departments of larger financial companies.

Investment Grade Bonds

this is a common credit rating that indicates low risk, highly rated bonds.

High Yield Bonds

This credit rating category generally involves more risk, but also offer higher potential rewards as compensation.

Non-rated Bonds

Bonds in this credit rating category are generally seen as the riskiest, although established financial institutions do research them in search of diamonds in the rough.

Two types of risk associated with bonds:

Interest Rate Risk

The general rule of thumb is that long term bonds get hit hardest by climbing interest rates, but they also gain most from falling interest rates.

Event Risk

This type of risk comes from the issuer in the form of company restructuring, mergers and other such activity. There is always the risk that these types of changes could reduce a bond's value.

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