Now when we have covered the basics i.e. “What are Bonds”, before we move further, let us try to see what are the common Bond terminologies or common terms related to bonds.
Basically if we see the complete cycle it is as follows:
1) Purchase the bonds when those are issued.
2) Get the yearly fixed interest rates.
3) If you wish to resale the bonds before the maturity period then you sale those at the current market value and if not then
4) Wait for the maturity date and trade it back for your initial amount paid.
5) But during this complete cycle you would like to keep an eye on the following:
• How much risk is associate with your bond i.e. risk about getting your initial investment back or who the bonds are rated as far as risk is concerned.
• What are the real returns on your investment. This is true for both cases i.e. whether you had purchased the bond during the initial offering or are going to purchase already issued bonds from the secondary market.
Now more or less we have seen all stages of the life cycle of the bond. The terminology related to bonds will nothing but representing all stages or all entities and are as follows:
Terminology Related to Bonds
- Issuer: Entity which issues the Bond.
- Face Value or Par Value: The initial offering price or the price at which bonds are offered at the time of issue.
- Interest Rate on the Bond: The interest rate committed by the Issuer.
- Coupon or Coupon Value: The actual amount which you receive as interest. Let us say that the bond face value is USD 5000 and Interest is 10% then the yearly Coupon is USD 500.
- Maturity: It is the end date of that bond’s life cycle i.e. when the investor gets his initial invested money back.
- Bond Rating: This is the rating of the issuer to see how safe or risky is the investment. There are major credit rating agencies which evaluate the ratings of the companies or even the governments on regular basis. We will check about these major rating agencies in the later posts. We will check upon the bond ratings in a later post.
- Yield: As we have seen that the bonds are resalable before their maturity date. Depending on the various economic factors the market price of the bonds can go higher than the initial price or can go low. Yield is nothing but a measure to see the real or net returns on our investment. so yield is returns divided by investment or Coupon Value Divided by The Bond Price at that time. Yield = (Coupon Value)/(Bond Market Price).
- Junk Bonds: If the credit rating of the issuer goes so low that the risk is considered very high then the status of bonds become Junk bond as your initial investment is in risk. Please note that even such bonds are traded as speculation if the yield on those is very high i.e. the bond market price is very low.
- Yield to maturity: If you hold the bonds till the maturity date then what are the total returns divided by the bond purchase price is Yield to maturity. In other words your profit amount till maturity date divided by the bond purchase price or total profit till maturity date.
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