What Is a Bond?

A bond is a fixed-income instrument that represents a loan made by an investor to a

borrower (typically corporate or governmental). A bond could be thought of as
an I.O.U. between the lender and borrower that includes the details of the loan and its
payments. Bonds are used by companies, municipalities, states, and sovereign governments
to finance projects and operations. Owners of bonds are debtholders, or creditors, of the
issuer.

Bond details include the end date when the principal of the loan is due to be paid to the bond
owner and usually include the terms for variable or fixed interest payments made by the
borrower.

KEY TAKEAWAYS

 Bonds are units of corporate debt issued by companies and securitized as tradeable
assets.
 A bond is referred to as a fixed-income instrument since bonds traditionally paid a
fixed interest rate (coupon) to debtholders.
 Variable or floating interest rates are also now quite common.
 Bond prices are inversely correlated with interest rates: when rates go up, bond
prices fall and vice-versa.
 Bonds have maturity dates at which point the principal amount must be paid back in
full or risk default.

Who Issues Bonds?

Bonds are debt instruments and represent loans made to the issuer. Governments (at all
levels) and corporations commonly use bonds in order to borrow money. Governments need
to fund roads, schools, dams, or other infrastructure. The sudden expense of war may also
demand the need to raise funds.

Similarly, corporations will often borrow to grow their business, to buy property and
equipment, to undertake profitable projects, for research and development, or to hire
employees. The problem that large organizations run into is that they typically need far more
money than the average bank can provide.

How Bonds Work

Bonds are commonly referred to as fixed-income securities and are one of the main asset
classes that individual investors are usually familiar with, along with stocks (equities) and
cash equivalents.

When companies or other entities need to raise money to finance new projects, maintain
ongoing operations, or refinance existing debts, they may issue bonds directly to investors.
The borrower (issuer) issues a bond that includes the terms of the loan, interest payments
that will be made, and the time at which the loaned funds (bond principal) must be paid back
(maturity date). The interest payment (the coupon) is part of the return that bondholders earn
for loaning their funds to the issuer. The interest rate that determines the payment is called
the coupon rate.1
The initial price of most bonds is typically set at at par, or $1,000 face value per individual
bond. The actual market price of a bond depends on a number of factors: the credit quality of
the issuer, the length of time until expiration, and the coupon rate compared to the general
interest rate environment at the time. The face value of the bond is what will be paid back to
the borrower once the bond matures.2

Most bonds can be sold by the initial bond holder to other investors after they have been
issued. In other words, a bond investor does not have to hold a bond all the way through to
its maturity date. It is also common for bonds to be repurchased by the borrower if interest
rates decline, or if the borrower’s credit has improved, and it can reissue new bonds at a
lower cost.

What Is a Government Bond?

A government bond is a debt security issued by a government to support government

spending and obligations. Government bonds can pay periodic interest payments
called coupon payments. Government bonds issued by national governments are often
considered low-risk investments since the issuing government backs them.

Government bonds are issued by governments to raise money to finance projects or day-to-
day operations.

KEY TAKEAWAYS

 A government bond represents debt that is issued by a government and sold to

investors to support government spending.
 Some government bonds may pay periodic interest payments. Other government
bonds do not pay coupons and are sold at a discount instead.
 Government bonds are considered low-risk investments since the government backs
them.
 The various types of bonds that are offered by the U.S. Treasury are considered to be
among the safest in the world.
 Because of their relatively low risk, government bonds typically pay low interest
rates.
 Some Treasury bonds trade in the secondary market. Individual investors, working
with a financial institution or broker, can buy and sell previously issued bonds
through this marketplace. Treasuries are widely available for purchase through the
U.S. Treasury, brokers, and exchange-traded funds (ETFs), which contain a basket of
securities.
 Fixed-rate government bonds can have interest rate risk, which occurs when interest
rates are rising and investors are holding lower paying fixed-rate bonds as compared
to the market. Also, only select bonds keep up with inflation, which is a measure of
price increases throughout the economy. If a fixed-rate government bond pays 2%
per year, for example, and prices in the economy rise by 1.5%, the investor is earning
only 0.5% in real terms.
 Local governments may also issue bonds to fund projects such as infrastructure, libraries, or
parks. These are known as municipal bonds, or "munis," and often carry certain tax
advantages and exemptions for investors.

Munis can be thought of as loans that investors make to local governments, and they are
used to fund public works such as parks, libraries, bridges and roads, and other
infrastructure. They may be funded via local tax dollars or by revenue generated from the
project (e.g. a toll road).

Although municipal bonds may have lower interest rates than riskier investments
like corporate bonds or stocks, they offer some stability and low default rates.

 
If you are interested in government bonds, you may want to acquaint yourself with the
following terms:

 Face or Par Value: the amount of debt you are loaning the government and the
amount you will get back when the bond matures
 Coupon: the regular interest payments credited to bondholders
 Yield: the interest rate on the bond after accounting for its market price
 Market Price: the price of the bond in the secondary market, which may differ from
the face value
 Treasuries: U.S. federal government bonds
 T-Bill: short-term Treasuries, maturing in 1 year or less
 T-Note: medium-term Treasuries, maturing in 2 to 10 years
 T-Bond: long-term Treasuries maturing in 10 to 30 years or longer
 TIPS: Treasuries that are indexed to inflation

Pros
 Pay a steady interest income return
 Low risk of default for U.S. bonds
 Exempt from state and local taxes
 A liquid market for reselling
 Assessable through mutual funds and ETFs

Cons
 Offer low rates of return 
 Fixed income falls behind with rising inflation
 Carry risk when market interest rates increase
 Default and other risks on foreign bonds

Buying vs. Trading Bonds

If you buy government bonds and hold them until maturity, you will enjoy regular coupon
(interest) payments and a return of your initial investment when they mature. During that
time, however, the price of a government bond will fluctuate in the market. Bond prices have
an inverse relationship with interest rates—so when interest rates go up, government bond
prices go down in the secondary market. Because of this, shorter-term investors who do not
buy and hold bonds until maturity can experience gains or losses in the market. Bond
traders can also look to profit from the relative differences in the yields of certain bonds,
known as the spread—for instance, the spread between U.S. Treasuries and highly rated
corporate bonds. Another bond trading strategy is to bet on changes in the spread between
different maturities, known as the yield curve.

Government bonds can provide a combination of considerable safety and relatively high
returns. However, investors need to be aware that governments sometimes lack the ability or
willingness to pay back their debts.

How Do You Buy Government Bonds?

U.S. Treasury securities are available to investors through their broker or bank, or
directly through the TreasuryDirect website. Investors can also look to ETFs or mutual funds
that invest in Treasuries. Municipal bonds are available via your broker.

How Do Government Bonds Work?

When governments need to raise funds for operations (e.g. paying government employees or
servicing interest charges on existing debt) or to invest in projects (e.g., building federal
highways), they can sell bonds to investors. In the U.S. case, bonds are sold through the
Treasury and represent debt owned by bondholders. These bondholders are credited with
interest and a return of their principal when the bond matures. This makes bondholders of
Treasuries essentially creditors (lenders) to the federal government.

What Are Example of Non-U.S. Government Bonds ?

Foreign governments around the world issue debt in the form of bonds. Some of these
commonly include:

 The U.K.: Gilts
 Germany: Bunds
 France: OATs
 Japan: JGBs
 Italy: BTPs
 Canada: Canada Bonds

Basic Bond Characteristics

A bond is simply a loan taken out by a company. Instead of going to a bank, the company
gets the money from investors who buy its bonds. In exchange for the capital, the company
pays an interest coupon, which is the annual interest rate paid on a bond expressed as a
percentage of the face value. The company pays the interest at predetermined intervals
(usually annually or semiannually) and returns the principal on the maturity date, ending the
loan.

Bonds are a form of IOU between the lender and the borrower.

six important features to look for when considering a bond.

Maturity

This is the date when the principal or par amount of the bond is paid to investors and the
company's bond obligation ends. Therefore, it defines the lifetime of the bond. A
bond's maturity is one of the primary considerations an investor weighs against their
investment goals and horizon. Maturity is often classified in three ways:

 Short-term: Bonds that fall into this category tend to mature within one to three years
 Medium-term: Maturity dates for these types of bonds are normally over ten years
 Long-term: These bonds generally mature over longer periods of time

Secured/Unsecured

A bond can be secured or unsecured. A secured bond pledges specific assets to bondholders if

the company cannot repay the obligation. This asset is also called collateral on the loan. So if
the bond issuer defaults, the asset is then transferred to the investor. A mortgage-backed
security (MBS) is one type of secured bond backed by titles to the homes of the borrowers.

Unsecured bonds, on the other hand, are not backed by any collateral. That means the interest
and principal are only guaranteed by the issuing company. Also called debentures, these
bonds return little of your investment if the company fails. As such, they are much riskier
than secured bonds.

Liquidation Preference

When a firm goes bankrupt, it repays investors in a particular order as it liquidates. After a
firm sells off all its assets, it begins to pay out its investors. Senior debt is debt that must be
paid first, followed by junior (subordinated) debt. Stockholders get whatever is left.

Coupon

The coupon amount represents interest paid to bondholders, normally annually or

semiannually. The coupon is also called the coupon rate or nominal yield. To calculate the
coupon rate, divide the annual payments by the face value of the bond.

Tax Status

While the majority of corporate bonds are taxable investments, some government
and municipal bonds are tax-exempt, so income and capital gains are not subject to
taxation.1 Tax-exempt bonds normally have lower interest than equivalent taxable bonds. An
investor must calculate the tax-equivalent yield to compare the return with that of taxable
instruments.

Callability

Some bonds can be paid off by an issuer before maturity. If a bond has a call provision, it
may be paid off at earlier dates, at the option of the company, usually at a slight premium
to par. A company may choose to call its bonds if interest rates allow them to borrow at a
better rate. Callable bonds also appeal to investors as they offer better coupon rates.
Risks of Bonds

Bonds are a great way to earn income because they tend to be relatively safe investments.
But, just like any other investment, they do come with certain risks. Here are some of the
most common risks with these investments.

Interest Rate Risk

Interest rates share an inverse relationship with bonds, so when rates rise, bonds tend to fall
and vice versa. Interest rate risk comes when rates change significantly from what the
investor expected. If interest rates decline significantly, the investor faces the possibility of
prepayment. If interest rates rise, the investor will be stuck with an instrument yielding below
market rates. The greater the time to maturity, the greater the interest rate risk an investor
bears, because it is harder to predict market developments farther out into the future.

Credit/Default Risk

Credit or default risk is the risk that interest and principal payments due on the obligation will
not be made as required. When an investor buys a bond, they expect that the issuer will make
good on the interest and principal payments—just like any other creditor.

When an investor looks into corporate bonds, they should weigh out the possibility that the
company may default on the debt. Safety usually means the company has greater operating
income and cash flow compared to its debt. If the inverse is true and the debt outweighs
available cash, the investor may want to stay away.

Prepayment Risk

Prepayment risk is the risk that a given bond issue will be paid off earlier than expected,
normally through a call provision. This can be bad news for investors because the company
only has an incentive to repay the obligation early when interest rates have declined
substantially. Instead of continuing to hold a high-interest investment, investors are left to
reinvest funds in a lower interest rate environment.

Bond Ratings

Most bonds come with a rating that outlines their quality of credit. That is, how strong the
bond is and its ability to pay its principal and interest. Ratings are published and are used by
investors and professionals to judge their worthiness.

Agencies

 The most commonly cited bond rating agencies are Standard & Poor’s, Moody's
Investors Service, and Fitch Ratings. They rate a company’s ability to repay its
obligations. Ratings range from AAA to Aaa for high-grade issues very likely to be
repaid to D for issues that are currently in default.
Bonds are debt securities issued by corporations, governments, or other organizations
and sold to investors.
  Backing for bonds is typically the payment ability of the issuer to generate revenue,
although physical assets may also be used as collateral.
 Because corporate bonds are typically seen as riskier than government bonds, they
usually have higher interest rates.
 Bonds have different features than stocks and their prices tend to be less correlated,
making bonds a good diversifier for investment portfolios.
 Bonds also tend to pay regular and stable interest, making them well-suited for those
on a fixed-income.

What Is a Bond?

When you purchase a stock, you're buying a microscopic stake in the company. It's yours
and you get to share in the growth and also in the loss. On the other hand, a bond is a type of
loan. When a company needs funds for any number of reasons, they may issue a bond to
finance that loan. Much like a home mortgage, they ask for a certain amount of money for a
fixed period of time. When that time is up, the company repays the bond in full. During that
time the company pays the investor a set amount of interest, called the  coupon, on set dates
(often quarterly).

There are many types of bonds, including government, corporate, municipal and mortgage
bonds. Government bonds are generally the safest, while some corporate bonds are
considered the most risky of the commonly known bond types.

For investors, the biggest risks are credit risk and interest rate risk. Since bonds are debts, if
the issuer fails to pay back their debt, the bond can default. As a result, the riskier the issuer,
the higher the interest rate will be demanded on the bond (and the greater the cost to the
borrower). Also, since bonds vary in price opposite interest rates, if rates rise bond values
fall.

Credit Ratings

Bonds are rated by popular agencies like Standard and Poor's, and Moody's. Each agency
has slightly different ratings scales, but the highest rating is AAA and the lowest rating is C
or D, depending on the agency. The top four ratings are considered safe or investment grade,
while anything below BBB for S&P and Baa3 for Moody's is considered "high yield"
or "junk" bonds.1

Although larger institutions are often permitted to purchase only investment grade
bonds, high yield or junk bonds have a place in an investor's portfolio as well, but may
require more sophisticated guidance. Generally, governments have higher credit ratings than
companies, and so government debts are less risky and carry lower interest rates.

Pricing Bonds

Bonds are generally priced at a face value (also called par) of $1,000 per bond, but once the
bond hits the open market, the asking price can be priced lower than the face value, called a
discount, or higher than the face value, called premium.2 If a bond is priced at a premium,
the investor will receive a lower coupon yield, because they paid more for the bond. If it's
priced at a discount, the investor will receive a higher coupon yield, because they paid less
than the face value.

Bond prices tend to be less volatile than stocks and they often responds more to interest rate
changes than other market conditions. This is why investors looking for safety and income
often prefer bonds over stocks as they get closer to retirement. A bond's  duration is its price
sensitivity to changes in interest rates—as interest rates rise bond prices fall, and vice-versa.
Duration can be calculated on a single bond or for an entire portfolio of bonds.

Bonds and Taxes

Because bonds pay a steady interest stream, called the coupon, owners of bonds have to pay
regular income taxes on the funds received. For this reason, bonds are best kept in a tax
sheltered account, like an IRA, to gain tax advantages not present in a standard brokerage
account.

If you purchased a bond at a discount, you'll be required to pay capital gains tax on the
difference between the price you paid and the bond's par value, normally $1,000 per bond,
but not until the bond matures and you receive the face value of the bond.3

Issuers of bonds, on the other hand, such as corporations, often receive favorable tax
treatment on interest, which they can deduct from their taxes owed.

Local governments and municipalities may issue debt too, known as municipal bonds. These
bonds are attractive to some investors as the interest payments to investors can be tax-free at
the local, state, and/or federal level.

Issuers of Bonds

There are four primary categories of bond issuers in the markets. However, you may also
see foreign bonds issued by corporations and governments on some platforms.

 Corporate bonds are issued by companies. Companies issue bonds—rather than seek

bank loans for debt financing in many cases—because bond markets offer more
favorable terms and lower interest rates.
 Municipal bonds are issued by states and municipalities. Some municipal bonds offer
tax-free coupon income for investors.
 Government (sovereign) bonds such as those issued by the U.S. Treasury. Bonds (T-
bonds) issued by the Treasury with a year or less to maturity are called “Bills”; bonds
issued with 1 to 10 years to maturity are called “notes”; and bonds issued with more
than 10 years to maturity are called “bonds”. The entire category of bonds issued by
a government treasury is often collectively referred to as "treasuries." Government
bonds issued by national governments may be referred to as sovereign debt.
Governments may also offer inflation-protected bonds (e.g. TIPS) as well as small
denomination savings bonds for ordinary investors,
 Agency bonds are those issued by government-affiliated organizations such as
Fannie Mae or Freddie Mac.
How to Buy Bonds

Most bonds are still traded over the counter (OTC) through electronic markets. For
individual investors, many brokers charge larger commissions for bonds, since the market
isn't as liquid and still requires calling bond desks in many buy and sell scenarios. Other
times, a broker-dealer may have certain bonds in their inventory and may sell to their
investors directly from their inventory.

You can often purchase bonds through your broker's website or call with the bond's unique
ID number, called the CUSIP number, to get a quote and place a "buy" or "sell" order.

Alternatives to Buying Bonds Directly

If you want the income earning power of a bond, but you don't have the funds or don't want
to own individual bonds, consider a bond ETF or bond mutual funds. These are well
diversified funds that give you exposure to many different bonds, and pay a monthly or
quarterly dividend.

Because some bonds have a minimum purchase amount, smaller investors may find these
products more appropriate for their smaller amount of capital, while remaining properly
diversified.

The Bottom Line

Most investors, regardless of age, should have at least a small amount of their portfolio
allocated to fixed income products such as bonds. Bonds add safety and consistency to a
portfolio. Although there is a risk that a company may default and cause a large loss,
investment grade bonds rarely default. However, along with this safety comes a lower rate of
return.

 
Before investing in bonds, always do further research into fixed income investing strategies.

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What are Par, Premium, and Discount Bonds?

Par Coupon rate = Yield

Premium Coupon rate > Yield

 Investors will pay a premium (higher price) for a bond that offers a
higher coupon rate than the market yield.
Discount Coupon rate < Yield

 Investors will pay a discount (lower price) for a bond that offers a
lower coupon rate than the market yield.

Examples of Bonds

1. Company A issues five-year bonds on January 1, 2018, which cost $100

each and pay 5%. The YTM is 6%.

What is the yield?

 The yield to maturity (YTM) is 6%.

What is the principal?

 The principal is $100.

What is the maturity?

 January 1, 2023 (the maturity date is in five years from the issue date).

What is the coupon rate?

 The coupon rate is 5%.

2. Company B issues two-year notes on March 1, 2018, which cost $500

each and pay 6%, with the first payment made six months after the issue
date. The YTM is 6%.

Which dates will the bondholder be paid?

 September 1, 2018
 March 1, 2019
 September 1, 2019
 March 1, 2020
How much will they be paid on each date?

 September 1, 2018: $500 * (6%/2) = $15

 March 1, 2019: $500 * (6%/2) = $15
 September 1, 2019: $500 * (6%/2) = $15
 March 1, 2020: $500 * (6%/2) + $500 = $515

*Note: 6%/2 because the coupon rate is annual but is paid semi-annually.

*Note: Last payment includes the principal.

3. A bond with a 5.5% yield is offering a 6% coupon rate. Will this bond’s
price be higher or lower than the principal?

 Higher, because it’s a premium bond (investors will pay a higher price
for the higher rate).

Government Bonds

The following are examples of government-issued bonds, which typically offer a lower
interest rate compared to corporate bonds.

1. Federal government bonds

The reduced yield is attributed to the federal government’s ability to print money and collect
tax revenue, which significantly lowers their chance of default. The U.S. government’s debt
is considered risk-free for this reason.

2. Treasury bills

 Maturity < 1 year

3. Treasury notes

 Maturity between 1-10 years

4. Treasury bonds

 Maturity > 10 years

5. Zero-coupon bond

Zero-coupon bonds make no coupon payments but are issued at a discounted price.
6. Municipal bonds

Bonds issued by local governments or states are called municipal bonds. They come with a
greater risk than federal government bonds but offer a higher yield.

Examples of Government Bonds

1. The Canadian government issues a 5% yield bond that only pays at maturity. What type of
bond is this?

 A zero-coupon bond (discount bond)

2. The U.S. government issues a 2% bond that matures in 3 years and a 3.5% bond that
matures in 20 years. What are these bonds called?

 2% bond: Treasury note (maturity is between 1-10 years)

 5% bond: Treasury bond (maturity is more than 10 years)

Corporate Bonds

Corporate bonds are issued by corporations and offer a higher yield relative to a government
bond due to the higher risk of insolvency. A bond with a high credit rating will pay a lower
interest rate because the credit quality indicates the lower default risk of the business.

1. Convertible bond

A company may issue convertible bonds that allow the bondholders to redeem these for a
pre-specified amount of equity. The bond will typically offer a lower yield due to the added
benefit of converting it into stock.

2. Callable bond

Callable bonds may be redeemed by the company before the maturity date is reached,
typically at a premium. It can be beneficial for a business operating in an environment where
interest rates are decreasing because the firm can reissue bonds with a lower yield.

3. Investment-grade bond

A bond with a high credit rating (minimum of “Baa” by Moody’s) is considered investment-
grade.

4. Junk bond

A junk bond comes with a credit rating of “BB” or lower and offers a high yield due to the
increased risk of company default.]
Examples of Corporate Bonds

1. Company A issues bonds with a high credit rating (above A) and may be converted to
stock. What type of bond is this?

 Convertible investment-grade bond

2. Company B notices a downward trend in interest rates and decides to redeem its low credit
rating (CC) bonds with a plan to reissue them at a lower rate. What type of bond are they
redeeming?

 Callable junk bonds

3. Company A issues a bond with a coupon rate of 3%, and Company B issues one with a
coupon rate of 7%. Which bond will most likely show a higher credit rating?

 The 3% bond because a lower yield typically indicates a lower chance of default, relative to
the 7% bond.

Related Readings

Thank you for reading CFI’s guide on Bonds. To keep learning and advancing your career,
the following resources will be helpful:

 Bond Pricing
 Debt Capital Markets
 Fixed Income Trading
 Introduction to Fixed Income Course

Different Types of Bonds

There are various types of Bonds. A few of them have been discussed below in brief.

 Traditional Bond: A bond in which the entire principal can be withdrawn at a single time
after the bond’s maturity date is over is called a Traditional Bond.
 Callable Bond: When the issuer of the bond calls out his right to redeem the bond even
before it reaches its maturity is called a Callable Bond. Through this type of bonds, the
issuer can convert a high debt bond into a low debt bond.
 Fixed-Rate Bonds: When the coupon rate remains the same through the course of the
investment, it is called Fixed-rate bonds.
 Floating Rate Bonds: When the coupon rate keeps fluctuating during the course of an
investment, it is called a floating rate bond.
 Puttable Bond: When the investor decides to sell their bond and get their money back
before the maturity date, such type of bond is called a Puttable bond.
  Mortgage Bond: The bonds which are backed up by the real estate companies and
equipment are called mortgage bonds.
 Zero-Coupon Bond: When the coupon rate is zero and the issuer is only applicable to
repay the principal amount to the investor, such type of bonds are called zero-coupon
bonds.
 Serial Bond: When the issuer continues to pay back the loan amount to the investor
every year in small instalments to reduce the final debt, such type of bond is called a
Serial Bond.
 Extendable Bonds: The bonds which allow the Investor to extend the maturity period of
the bond are called Extendable Bonds.
 Climate Bonds: Climate Bonds are issued by any government to raise funds when the
country concerned faces any adverse changes in climatic conditions.
 War Bonds: War Bonds are issued by any government to raise funds in cases of war.
 Inflation-Linked Bonds: Bonds linked to inflation are called inflation linked bonds. The
interest rate of Inflation linked bonds is generally lower than fixed rate bonds

ning of Bonds When a company has to raise long term debt, one of the modes of raising the
funds is by issuing debentures. For all practical reasons, a debenture and a bond are one and
the same. Bonds or debentures can be called financial Instruments which are contracts that give
rise to a financial liability for one party (the one who issues such bonds) and a financial asset for
the other party (the one who holds such bonds or debentures). Bond is a fixed income bearing
security that provides interest at a definite rate to the investors. When an investor acquires a
bond, he expects interest over the period and the redeemable value to be received at the
maturity date or redemption date. In other word, after acquiring a bond, the investor receives a
stream of cash flows. The total present value of such stream of cash flow (including the present
value of redeemable value) is considered as the value of such bond. For the purpose of bond
valuation the following terms must be clarified: 1. Face Value 2. Coupon Rate 3. Coupon
payments 4. Issue Price 5. Market Price 6. Maturity Date 7. Redemption Price 8. Intrinsic Value
9. Callable & Puttable Bonds 10. Call Date & Call Price 11. Current Yield 12. Yield to Maturity
(YTM) 13. Yield to Call (YTC) (For Callable Bonds) 14. Zero Coupon Bonds (ZCB) 15. Deep
Discount Bonds (DDB) 16. Annuity Bonds 17. Bond STRIPS 18. Par Bonds, Premium Bonds and
Discount Bonds 19. Convertible Bonds (OCDs & CCDs) 20. Straight Value of Convertible Bond
21. Stock Value of Convertible Bond 22. Conversion Parity Price 23. Conversion Premium 24.
Clean Price & Dirty Price Issue Price of a bond is at which a new bond is priced by the issuer.
Bonds can be issued at Par, Premium or Discount. Market Price of a bond indicates the price at
which the bond can be bought or sold in the open market. What do you mean by Coupon Rate
and Coupon Payments? Suppose a bond promises to pay interest at the rate of 8% per annum,
then such rate is called “Coupon Rate”. The Coupon Rate is always applicable on the face value
of the bond irrespective of its issue price or prevailing market price. For example, 9%
Government of India Bonds provide half yearly interest on 30th June and 31st December. The
face value of the bond is ` 1,000. The interest paid on each bond will be ` 1,000 x 9% x 6/12 = `
45 on each of the interest payment dates. The interest payment of ` 45 during each of the
months June and December are known as “Coupon Payments”. Coupon Rate is the rate of
interest attached to the bond and it applies on the face value, for example, a 9% bond with face
value of ` 1,000 will have interest payments of ` 1,000 x 9% = ` 90 every year. It should be noted
that the interest on bonds can be payable quarterly, half yearly or annually in general. What is
the Intrinsic Value of the Bond? Intrinsic value of the bond is the aggregate present value of all
coupon payments and the redemption amount, determined by using a discounting rate which is
expected rate of return by the investor. Maturity Date of a bond is the date at which a bond is
redeemable or is due for redemption. A bond is generally redeemed at par or premium. Bond
Valuation: Basic Principle As discussed earlier, the present value of the stream of cash flows
including the present value of the redemption price is considered as the value of the bond and
more specifically the intrinsic value of the bond or the fair market value of the bond (For this
purpose the market price of the bond is always called as Actual Market Price and not Fair Market
Price). In order to arrive at the present value of the stream of cash flows, a discounting rate has
to be used. This discounting rate is known as the desired yield rate or required yield rate. In other
words the discounting rate is the required rate of return by the investor. As generally known,
increasing the discounting rate results into reduction in present value, and the decrease in
discounting rate increases the present value. It can be concluded that the discounting rate or the
desired yield rate and bond value are inversely related. Face Value; Intrinsic Value & Market
Value: (Classification of the bond as Par, Premium or Discount bond) At the time of issue: If the
bond is issued at its face value it is par bond If issued above its face value it is premium bond If
issued below its face value it is discount bond Once the bond is floated: Then comparison is
made among the three values: • Face Value • Intrinsic Value and • Market Value. #Bonds , #Fin