A bond is a debt instrument which represents a loan to the issuer.
Bonds generally pay periodic interest payments to the bond holder.
Bonds are generally issued for a finite period. The end of the bond’s term is known as the maturity date. At the maturity date the issuer must pay the bond holder the bond’s principal. Bonds usually have a face value, or original issuance value, of $1,000. The face value is also known as the par value.
The periodic interest payments are known as coupon payments, or coupons. The coupon rate is the coupon divided by the bond’s face value. For example, if a bond pays an annual coupon of $80, and the bond’s face value is $1,000, the bond has an annual coupon rate of 8%.
A bond may be issued at a discount or a premium to the bond’s face value. When a bond is issued at a discount or premium, the issuing company must amortize the discount or premium over the life of the bond.
Bonds also trade on secondary securities markets and bond prices can fluctuate. Two yield measures are used to capture the relationship between bond prices and the coupon payment. First is the yield-to-maturity (YTM). The YTM is the rate which equates the present value of the bond’s future cash flows (coupon payments and principal amount) with the bond’s market price. Second is the current yield, which is calculated by dividing the coupon by the bond’s market price. Bond prices move inversely with these two rates. When bond prices fall, the current yield and YTM rise. When bond prices rise, the current yield and YTM fall.
Bonds may be issued by corporations or governments. The largest bond market in the world is the U.S. Treasury market.
