Understanding Bond Terminology

Table of Contents
Chapter 1: What are Bond Investments
Chapter 2: Categories of Bonds
Chapter 3: Understanding Bond Terminology
Chapter 4: Who Should Buy Bonds
Chapter 5: How to Buy and Sell Bonds
Chapter 6: Factors to Consider Before Buying Bonds

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Face Value
Fixed Variable Coupon Rates
Variable Coupon Rates

Chapter 3: Understanding Bond Terminology

In order to make the right bond investment decision, it is necessary to understand the cost and returns on it. Here is an overview of the various terms used with a bond to help you make a cost- benefit analysis.

Face Value – The face value of a bond is what you will get back when the bond matures. Also referred to as par value, it is different from the price that a bond sells at in the secondary market, although a newly issued corporate bond may sell at this price. A bond can sell at a premium or at a discount in the secondary market, as its price fluctuates with market conditions. But a bond holder is insulated from these fluctuations as long as he retains the bond.

To understand this better, take the example of a normal, non-discounted bond. The face value will be the same as purchase price only at the time of issue. If you buy this bond later, then market forces would have caused this bond’s price to change although the face value remains constant.

For a zero coupon bond which has a face value of $2,000, the actual discounted price you will pay at time of issue may well be $1,000. After the specified term of the bond expires, say 20 years, you will be paid back $2,000. The zero coupon bond you bought for $1000 may cost much more than that in the open market and its price will depend on many factors, including how far the maturity date of the bond is at that time.

Maturity – This denotes the term or life of the bond and specifies the date on which you will be paid back your principal amount. The longer the term, the higher the risk because the chances of markets turning volatile or the issuer facing financial trouble is much higher when the period is longer. This is why longer term bonds come with higher returns to make them more attractive. Bond terms can range from as little as a few days to decades.

Coupon – The interest rate which the issuer pays on your loan is the coupon on the bond. Most bonds come with semi annual interest payments. The coupon is mentioned as a percentage of a bond’s face value.

Fixed Variable Coupon Rates – Fixed rates are those which are specified at the time of bond issue and remain the same throughout the term of the bond.

Variable Coupon Rates – Variable rates are often linked to an index, in a similar way as variable rates of a mortgage.

Next Chapter: Who Should Buy Bonds