Introduction to Bonds

By Cristina Resetnic, ASEM, FB 29 G



In finance, a bond is a debt security, in which the authorized issuer owes the
holders a debt and, depending on the terms of the bond, is obliged to pay interest
(the coupon) and/or to repay the principal at a later date, termed maturity. A bond
is a formal contract to repay borrowed money with interest at fixed intervals.
Issuing bonds

Bonds are issued by public authorities, credit institutions, companies and

supranational institutions in the primary markets. The most common process of
issuing bonds is through underwriting. In underwriting, one or more securities
firms or banks, forming a syndicate, buy an entire issue of bonds from an issuer
and re-sell them to investors. The security firm takes the risk of being unable to
sell on the issue to end investors.
Features of bonds

Bonds have a number of characteristics of which you need to be aware. AII of these
factors play a role in determining the value of a bond.
Coupon (The Interest Rate)

The coupon is the amount the bondholder will receive as interest payments. It's
called a "coupon" because sometimes there are physical coupons on the bond that you
tear off and redeem for interest. However, this was more common in the past.
Nowadays, records are more likely to be kept electronically. As previously
mentioned, most bonds pay interest every six months, but it's possible for them to
pay monthly, quarterly or annually. The coupon is expressed as a percentage of the
par value.
Maturity

The maturity date is the date in the future on which the investor's principal will
be repaid. As long as all payments have been made, the issuer has no more
obligation to the bond holders after the maturity date. The length of time until
the maturity date is often referred to as the term or tenor or maturity of a bond.
There are three groups of bond maturities: short term (bills): maturities up to one
year; medium term (notes): maturities between one and ten years; long term (bonds):
maturities greater than ten years A bond that matures in one year is much more
predictable and thus less risky than a bond that matures in 20 years. Therefore, in
general, the longer the time to maturity, the higher the interest rate. Also, all
things being equal, a longer term bond will fluctuate more than a shorter term
bond.

Issuer

The issuer of a bond is a crucial factor to consider, as the issuer's stability is

your main assurance of getting paid back.
For example, the U.S. government is far more secure than any corporation. Its
default risk (the chance of the debt not being paid back) is extremely small - so
small that U.S. government securities are known as risk-free assets. The reason
behind this is that a government will always be able to bring in future revenue
through taxation. A company, on the other hand, must continue to make profits,
which is far from guaranteed. This added risk means corporale bonds must offer a
higher yield in order to entice investors - this is the risk/return tradeoff in
action.
Types of bonds

Fixed rate bonds have a coupon that remains constant throughout the life of the
bond. Floating rate notes (FRNs) have a variable coupon that is linked to a
reference rate of interest, such as LIBOR or Euribor. Inflation linked bonds. in
which the principal amount and the interest payments are indexed to inflation. The
interest rate is normally lower than for fixed rate bonds with a comparable
maturity. Asset-backed securities are bonds whose interest and principal payments
are backed by underlying cash flows from other assets.
Types of bonds

Subordinated bonds are those that have a lower priority than other bonds of the
issuer in case of liquidation. Perpetual bonds are also often called perpetuities
or Perps'. They have no maturity date. Bearer bond is an official certificate
issued without a named holder. In other words, the person who has the paper
certificate can claim the value of the bond. Often they are registered by a number
to prevent counterfeiting, but may be traded like cash. Bearer bonds are very risky
because they can be lost or stolen. War bond is a bond issued by a country to fund
a war.
How To Read A Bond Table
Column 1: Issuer - This is the company, state (or province) or country that is
issuing the bond. Column 2: Coupon - The coupon refers to the fixed interest rate
that the issuer pays to the lender. Column 3: Maturity Date - This is the date on
which the borrower will repay the investors their principal. Typically, only the
last two digits of the year are quoted: 25 means 2025, 04 is 2004, etc. Column 4:
Bid Price - This is the price someone is willing to pay for the bond. It is quoted
in relation to 100, no matter what the par value is. Think of the bid price as a
percentage: a bond with a bid of 93 is trading at 93% of its par value. Column 5:
Yield - The yield indicates annual return until the bond matures. Usually, this is
the yield to maturity, not current yield.
Conclusion

Bonds are just like lOUs. Buying a bond means you are lending out your money. Bonds
are also called fixed-income securities because the cash flow from them is fixed.
The issuers of bonds are governments and corporations. A bond is characterized by
its face value, coupon rate, maturity and issuer. Yield is the rate of return you
get on a bond. When price goes up, yield goes down, and vice versa. When interest
rates rise, the price of bonds in the market falls, and vice versa. Bills, notes
and bonds are all fixed-income securities classified by maturity. Government bonds
are the safest bonds, followed by municipal bonds, and then corporate bonds. Bonds
are not risk free. It's always possible - especially in the case of corporate bonds
- for the borrower to default on the debt payments.
Vocabulary

Bond- are debt and are issued for a period of more than one year. Underwriting- the
process of placing a new issue with investors. Syndicate - a group of banks that
acts jointly, on a temporary basis, to loan money in a bank credit (syndicated
credit) or to underwrite a new issue of bonds. Coupon - the annual interest paid on
a debt security. Maturity- the date on which payment of a financial obligation is
due. Issuer- an organization that is selling or has sold its securities to the
public. Bid Price- this is the quoted bid, or the highest price an investor is
willing to pay to buy a security. Yield- the percentage return paid on a stock in
the form of dividends, or the effective rate of interest paid on a bond or note.
IOU- "I owe you. An IOU in the business community is actually a legally binding
agreement between a borrower and a lender.