Key Features of Every BondNovember 26th, 2011 by David Waring
While sometimes all the bond market terminology being thrown around can be a little overwhelming, if we break down each of the components that make up a bond into individual pieces you can see that its not such a daunting task after all. So lets jump right in
Every bond has a unique CUSIP number, composed of a combination of nine letters and numbers. Just like every stock has a ticker symbol, every bond has a CUSIP number for identification.
Par Value (also referred to as Face Value)
This is the amount that the bond will be worth at maturity. In other words if you buy a 30 year bond with a par value of $1000 then, in addition to any interest you earned before the 30 year maturity, at the end of 30 years you get back $1000.
This is the price that an investor pays for a bond when it is first sold to the public. Depending on the type of bond, this can be close to, or the same amount as the par value. This is also the amount that the company or government who is issuing the bond receives, minus any fees they pay as a part of their bond offering.
While not a component of a bond, you will often see the bond’s market Price, the dollar amount at which people are currently buying and the selling bond, reported in financial press or market tables. Once a bond is sold, the price may fluctuate significantly from its issue price depending on change in interest rates and other factors.
The maturity date is when the money that was originally loaned to the entity that issued the bond, is repaid to the current bond holder. In other words, this is the date when the face value of the bond will be paid, and the relationship between the purchaser of the bond and the issuer of the bond ends. When people say they bought a 10 year bond, what they mean is they bought a bond that will be maturing in 10 years.
The coupon rate is the amount of interest that a bond pays. The interest is usually distributed to the bond holder on a semi-annual basis. Most bonds pay a fixed coupon, a set dollar amount that does not change. For example, if the coupon rate is 7% on a $10,000 bond, the bond holder would receive two payments of $350 per year until maturity.
Before the Internet, when you bought a bond you actually got a paper bond with coupons attached to it. When it came time to collect an interest payment, you would tear off that dates coupon and, depending on the type of bond, either take it to the bank, or mail it off. In return you got a check for the interest you were owed on that coupon. Luckily those days are long gone and everything is done electronically now, but the name coupon stuck.
This is an attempt to quantify the likelihood that the holders of a particular bond will get receive all their interest payments and full face value of the bonds on the maturity date. We cover all the factors that go into a bond’s credit rating here.
This is the contract that lays out the terms and conditions of the bond offering between the company or government issuing the bond (the debtor) and the institutions and/or individuals who are buying them (creditors).
The covenants are the individual terms and conditions outlined in the Indenture.
The dates in which the bond issuer pays the bond holder their interest. On many bonds this happens every 6 months, however there are exceptions which we discuss in later lessons.
Some bonds have built in features which give certain rights to the issuer. The most common is the right to call the bond (prepay the face value prior to the maturity date and therefor stop paying interest) . This is a key feature, as it can really affect the value of a bond over time, and therefore we have a specific lesson on it here.
Certain types of bonds, specifically treasury and municipal bonds, have tax advantages, such as the interest earned being free from state, local or federal income tax. To learn more about this visit our section on bonds and taxes.