Define: Bonds and What You Need To Know
Par or Face Value of a bond is what the investor will receive in cash once the bond matures or the return of the principal to the investor. Bonds may also be called, which is the term for when an issuer pays on bonds before the maturity date. Par value for corporate bonds is usually $1,000; for government bonds it may run much higher. Most bonds are likely to be issued in multiples of $1,000.
Coupon Rate is the amount of interest the investor will receive for each year of the bond’s term, expressed as a percentage of the par value. For example, a bond with a par value of $1,000 and a coupon rate of 6.5 percent,will pay $65 in interest to the investor each year.
Maturity Date is the date on which the principal on a bond is due back to the investor, and payment of interest ceases. Government bond maturities range from 90 days for a Treasury Bill ( a coupon issued by the U S Treasury) to 30 years for the ‘Long Bond’. Corporate and Municipal bonds usually have terms from 1 to 10 years. If a company wants to pay back early the debt raised by a bond, it’s referred to as “calling” the bond. All corporate and municipal bonds specify whether they are eligible to be called, and if so, the earliest date they can be called. Federal government bonds are never called. Just like me on a Friday night.
The interest rate on a bond is determined by two of its features:
The Credit Quality measures the borrower’s ability to repay the debt, and the risk of default. Lots of independent rating services like Standard and Poor’s (yep, that S & P) or Fitch’s Ratings grade the bonds from AAA to C, with D being held for bonds in default of payment. So when you hear of a security being downgraded, it means that its credit-worthiness is being questioned, and it has become a less than ideal investment.
S & P’s rating system looks like this:
AAA and AA: High credit-quality investment grade
AA and BBB: Medium credit-quality investment grade
BB, B, CCC, CC, C: Low credit-quality (non-investment grade), or "junk bonds"
D: Bonds in default for non-payment of principal and/or interest
Duration is a very complex term but essentially it’s a weighted average life of the future cash flows (interest payments or return of principal) on a bond. Think of it as a measurement of how long (in years) it takes for the price of a bond to be repaid by its internal cash flows. Expressed in years, it’s used to measure of the security’s value to fluctuations in interest rate. Bonds with higher durations carry more risk and higher price volatility than bonds with lower duration.
In general, bonds are a ‘safer’ investment. In exchange for that relative safety, you are unlikely to experience high short term growth, but they can be used as an offset to riskier investments and can bring more stability to your investment portfolio.
So yes, bonds are more like Ms Moneypenny than Jinx (Halle Berry’s Bond girl), but hey, it’s Ms. Moneyponey who got a recurring role in the Bond movies. Never overlook the woman wearing all her clothes.