Bonds 101 Part Two
In my first piece on bonds for beginners, I told you that a bond is a contract that involves paying money with interest back at set times. The issuer of the bond could be considered the borrower, the bond holder could be considered the lender, and the maturity date is when the money is due. Bonds will be issued by credit institutions, companies, and public authorities. Now a little more on the details of bonds.
Bonds have an issue price, which is what the investors will pay when they first purchase the bonds and this will typically be about the same as the nominal amount. (The nominal amount, I wrote in article one, is the amount of money on which the issuer pays interest.) The maturity date of a bond is the date when the issuer has to pay back the nominal amount. After the maturity date, if all payments have been made, the issuer has no more obligations to the bond holders. The maturity could be any amount of time, and most bonds have a term of up to thirty years. In the U.S., there are three types of bond maturities: short term, which last up to one year, medium term, which last between one and ten years, and long term bonds, which last longer than ten years.
Bonds have a coupon, which is the interest rate that the issuer pays to the bond holders. Generally this rate is fixed throughout the life of the bond. The quality of the bond refers to the probability that bondholders will get the amounts that are promised at the due dates. This depends on a couple of things including indentures and covenants. An indenture is the formal debt agreement that lays down the terms of the bond, while covenants are the clauses of this agreement. With the coupon comes coupon dates, which are the dates on which the issuer pays the interest to the bond holders. In the United States, most bonds are semi-annual. Sometimes bonds will come with options, which are certain rights that are granted to the issuer or holder. Callability is one.
Callable bonds give the issuer the right to repay the bond before the maturity date on the call dates. Putability is another option. Putable bonds give the holder the right to force the issuer to pay back the bond before the maturity date on the put dates. A convertible bond permits a bondholder to exchange a bond to a number of shares of the issuer\’s common stock, and an exchangeable bond allows a bondholder to exchange a bond for a number of shares of a corporation that is not the issuer.
When a bond is issued, the interest rate that the issuer must pay is influenced by a number of factors like current market interest rates, the length of the term, and the creditworthiness of the issuer. These are all factors that will probably change over time, so the market price (the present value of all future interest that is expected to be collected and principal payments) of a bond will differ after it is issued.
Mallory Megan works for Rapid Recovery Solution and writes articles on nationwide collection agencies.
