Bonds: A bond is a debt instrument issued by a company or the government to raise capital by borrowing from investors. The investors in bonds are debt holders (lenders/creditors). The bond issuer is obliged to pay bondholders interest (the coupon) at a pre-decided rate and to repay the principal on a due date known as the maturity date. Like bank deposit receipts, bond issuers provide standardized certificates to bondholders, though most are now electronic. Bonds, as debt securities, can be easily bought or sold in financial markets.
Terms Related to Bonds:
- Accrued Interest: Interest that accumulates on a bond between coupon payments.
- Basis Point: The smallest measure used when quoting yields on bonds and notes. One basis point equals 0.01% of yield. For example, a bond’s yield changing from 5.89% to 6.42% would represent a 53 basis point movement.
- Basis Price: The price of a security expressed as a yield or percentage of return on the investment.
- Bid Price: The price a buyer is willing to pay for a security.
- Bid List: A schedule of bonds distributed by a holder or broker to dealers to solicit bids or current prices on the bonds.
- Bond Issuer: The entity (organization or government) that borrows money by selling bonds. The issuer pays regular interest and repays the principal at maturity.
- Bond Term: The duration between a bond’s issue date and maturity. Bonds with terms under four years are short-term, those between 4-10 years are intermediate-term, and those beyond 10 years are long-term bonds.
- Callable Bonds: Bonds that can be redeemed or paid off by the issuer before their maturity date. When called, the issuer pays the call price (usually the bond’s face value) and accrued interest, stopping further interest payments.
- Convertible Bonds: Fixed-income corporate debt securities that yield interest payments but can be converted into a predetermined number of equity shares.
- Coupon: The periodic interest rate paid by the bond issuer to bondholders, calculated on the bond’s face value. For example, an 8-year, Rs. 5000 bond with a 6% coupon rate pays Rs. 300 annually, regardless of market price changes.
- Credit (Default) Risk: The risk of the bond issuer defaulting on interest or principal payments. Government bonds typically have the lowest credit risk, while corporate bonds, especially from low-rated companies, carry higher credit risk.
- Credit Quality of a Bond: A measure of a bond’s creditworthiness, indicating the likelihood of default. It influences the investment quality of bond funds.
- Discount on Bonds: The difference between a bond’s face value and its issue price when the stated interest rate is lower than the market interest rate.
- Duration: A measure of a bond’s price sensitivity to interest rate changes, expressed in years.
- Face Value: The price of a single bond unit issued by an enterprise, also known as principal, nominal, or par value. Issuers must return this value to investors upon maturity.
- Inflation Risk: Bonds are susceptible to inflation risk since their fixed interest payments lose value during inflationary periods.
- Issue Date: The date a bond is issued and available for purchase. Interest accrues from this date.
- Interest Rate Risk: Bonds and interest rates share an inverse relationship; rising rates typically lower bond prices and vice versa.
- Junk Bonds: Non-investment-grade or speculative bonds offering higher potential returns to attract buyers.
- Maturity: The date when a bond’s principal (face value) is repaid, and interest payments cease.
- Par Value: The amount returned to bond investors by the issuer upon maturity.
- Price of a Bond: The actual amount paid to purchase a bond.
- Rating Agencies: Organizations assessing the financial strength of entities, especially their ability to meet bond obligations.
- Tradable Bonds: Bonds that can be bought and sold in the secondary market. Ownership can shift among investors during the bond’s tenure.
- Yield to Call (YTC): The annualized return an investor receives if a callable bond is held until its call date, prior to maturity.
- Yield to Maturity (YTM): The total return an investor earns by reinvesting periodic coupon payments at a fixed rate until maturity. YTM varies based on the bond’s purchase price. For example, if market interest rates rise to 6%, bonds with a 5% coupon rate trade at a discount, resulting in a higher YTM than the coupon rate for new buyers.
