Bond Definitions

[Igor 10]

Bond Definitions

 

Bond

A bond is a long-term loan to the government, a municipality, a corporation, or even an individual. The terms of the loan are contained in an agreement between the borrower and the bond trustee, who represents the interests of the bondholders.

 

Bond Trustee

An independent third party selected by the borrower to handle bookkeeping on a bond. The trustee represents the interests of the bondholders.

 

Note

A note is a medium-term loan to the government, a municipality, or a corporation. The terms of the loan are contained in an agreement between the borrower and the note trustee, who represents the interests of the noteholders. (Also called a bond.)

 

Debt Instrument

Debt instrument is the general term used to describe both a note and a bond.

 

Fixed-Income

Bonds and notes pay a specified amount of interest. The dollar amount of the interest payments is fixed and does not change for the life of the loan. Bonds and notes are therefore called fixed-income investments.

 

Issuer

The issuer is the name of the borrower.

 

Principal

Principal is the amount of each bond or note. It is the amount of the loan. Principal, par value, and face value are interchangeable terms.

 

Par Value

Par value is the denomination of the note or bond. It is the original amount of the loan. Generally, it is $1,000.

 

Face Value

Face value is the same as par value. It is the denomination amount of the note or bond. Generally, it is $1,000.

 

Coupon

Coupon is the specified amount of interest on the bond. It is fixed for the term of the loan.

 

Maturity Date

Maturity date is the date the bond will be repaid in full.

 

Accrued Interest

Accrued interest is the amount of interest that has been earned on the bond since the last payment date. Interest is earned every day, but only paid twice a year. So the accrued interest amount increases every day until it is paid.

 

Interest Rate

Interest rate is the cost of the loan to the borrower. The coupon and interest rate are the same. It does not change for the term of the loan.

 

Yield

Yield is the relationship between the coupon of the bond and its current price. The coupon does not change, but the price of the bond does. The yield changes as the price of the bond changes. If the bond price declines, the yield increases, and vice versa.

 

Yield to Maturity

Yield to maturity is the amount we earn on a bond every year until it is paid. This takes into account the interest paid and the discount or premium of the bond price to its par value.

 

Municipal Bonds

Municipal bonds are loans to a municipality. The loan is usually to establish or improve facilities or services that benefit residents. The bondholder does not have to pay tax on the interest payments. Therefore, the interest rates on municipal bonds are generally lower than on corporate bonds.

 

Corporate Bonds

Corporate bonds are loans made to corporations. Unless the bonds are held in a tax-exempt account (like an IRA), bondholders pay taxes on the interest.

 

Credit Rating

A credit rating is a report issued by a credit rating agency – like Moody's or Standard and Poor's. It estimates the chances of default. Credit ratings are important because they determine the interest rate the borrower has to pay. The higher the chance of default, the higher the interest rate.

 

High-Yield Bonds

High-yield bonds are a part of the corporate bond markets. Issuers in this market are more likely to default and therefore, pay more to borrow.

 

Junk Bonds

Junk bonds is a nickname for high-yield bonds.

 

Call

Call is a prepayment right given to the borrower by the bondholders. The borrower may "call" the bond for early repayment at a specified date, the call date, and for a specified amount, usually at a premium to the par value.

 

Basis Point

Basis point is one hundredth of one percent. There are 100 basis points in each 1%. The differences in bonds are often quoted in basis points. For example, an investment-grade bond pays 60 basis points (0.6%) less than a non-investment grade bond.

 

Default

Default occurs when the borrower cannot make either principal or interest payments as agreed. The borrower is in violation of the loan agreement and may be forced into bankruptcy.