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Useful Definitions and Information About Bonds

In: Business and Management

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Useful Definitions and Information about Bonds

Here is some terminology to remember:

Bond: Long term debt instruments issued by corporations or governments
Face Value (or par value or maturity value): The promised repayment at the end of the loan
Coupon: The regular interest payments promised by the bond issuer
Coupon Rate: Annual coupon payment divided by the face value
Time to maturity: Number of years remaining to the face value payment (notice that ‘time to maturity’ for a bond decreases as time passes since the maturity date is a fixed, pre-determined date)
Yield to Maturity (or required return or market rate): The rate of return that is required by the market for the bond at hand. Don’t be surprised to observe that the Yield to Maturity (YTM) may differ from the Coupon Rate in many occasions. This happens since coupon rate is fixed over the term of the bond, but YTM is a dynamic figure that is shaped by factors relating to the bond issuer and/or the general economy (e.g. interest rate movements in the economy or changes in the default-risk of the issuer).

More formally, a bond is evidence of debt issued by a corporation or a governmental body. A bond represents a loan made by investors to the issuer. In return for his/her money, the investor (or bondholder or lender) receives a legal claim on future cash flows of the borrower.

The issuer promises to:
- Make regular coupon payments every period until the bond matures, and
- Pay the face/par/maturity value of the bond when it matures.

Default - since the above mentioned promises are contractual obligations, an issuer who fails to keep them is subject to legal action on behalf of the lenders (vs. unlimited liability in equity markets).

The features of a particular bond are specified in a legal document called ‘indenture’. The indenture specifies the usual characteristics of a bond (face…...

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