Bond

Bond is a fixed income security, using which a company or a government, known as bond issuer, raises debt from the investors, known as bond holders. Based on the bond indenture (contract), the issuer is obligated to pay a specified amount of money as interest on the debt taken, to the holders, at specified future dates mentioned in the indenture.

There are different types of bonds such as bonds that do not pay interest (Zero Coupon bonds), bonds that can be redeemed prior to the specified maturity date (Callable bonds), bonds that can be exchanged for the shares of a company (Convertible Bonds) etc. Most of the corporate or government bonds are publicly traded on exchanges, while others are traded over-the-counter (OTC).

Bonds are used by companies, municipalities, states, sovereign governments and other entities to raise money for various activities such as fulfilling operating needs, completing specific projects, infrastructure spending, etc. They may issue bonds directly to investors instead of obtaining loans from various banks to raise the capital needed. When an investor purchases a bond, they are actually loaning that amount of money to the bond issuer and in return, collect timely interest payments. When the bond matures, the issuer repays the principal to the investor along with any remaining cash flows.

The basic terminology that is used in bond are:

Face Value/ Par value  - Par value or face value is the amount that the investor will receive at the time of maturity. For example, if the investor bought a bond at a par value of $1000. At the maturity date, the investor will get back the $1000.

Coupon Rate - Coupon rate is the rate of interest paid on the face value of the bond for a fixed interval of time. Typically intervals are annual or semi-annual. For example, if the coupon rate is 5% on the face value of $1000, the issuer of the bonds pay $50 in interest on each bond annually. Coupon rates are generally quoted annually. If the time interval in the above example was semi-annual, $25 interest payment is made by the bond issuer, twice a year, to the bondholder.

Maturity date - Maturity is the date on which the bond will mature and the bondholder receives the par value of the bond.

Issue Price - Issue price is the price at which the bond issuer originally sells the bonds in the market. This price is discovered in the market, which is majorly based on the coupon rate of the bond by the issuer, the market interest rate at that point in time, the credit risk of the issuer, and other issuer related factors. This issue price may or may not be different from the par value of the bond. The debt raised by the bond issuer is the issue price multiplied by the number of bonds sold.