Bond Terms

Article for Hindu Business Line

Look out for the basics of bonds

1. Par value: It is the value on the face of the bond that signifies the amount to be returned to the investor when the bond elapses (meaning its maturity date). The term par means on being on the same plane being the same amount initially invested is returned back to the investor.

2. Yield to maturity (YTM): It is the defined as the rate of return expected on a bond if it is held till the maturity date. It is a mode of equaling cash flows of interest payments and principal payments with the price of the bond. The general assumption is that all the coupons are reinvested at the same rate. YTM is greater than the current yield if the bond is selling at a discount and is less than the current yield if the same is selling at a premium.

3. Current Yield: Current Yield is the coupon interest amount divided by the purchase price of the bond. For instance if the bond is purchased at Rs. 1000 and the interest rate is 5% (Rs. 50). Here the current yield is
Current Yield = Interest amount / Purchase price of the bond
= 50 / 1000
= 0.50 (usually expressed in percentage)

4. Bond Yield: It is the rate of return on the bond that considers the sum of interest payment, redemption value at the bond’s maturity and the initial purchase price of the bond.

5. Coupon rate: It is the interest rate that the issuer of the bond promises to pay the bondholder against the principal per annum. Say for instance if the value of the bond is Rs. 1000 and the interest amount for the year is Rs 50, we can entail from the above that the coupon rate is 5%. Many bonds pay interest semi annually.

6. Par Bond: A par bond is a bond that is selling at its face value. Par value means the value without considering discount or premium.

7. Premium Bond: If a bond's price is higher than its par value it is selling at a premium, therefore the bond is called as a premium bond. This occurs because the interest rate on the bond is higher than the prevailing rates in the market, making the bond worth more than a lower interest paying bond. For instance, if a bond with a 5% coupon were selling at par (Rs. 1000), it would be worth less than the bond paying 7%. Therefore the bond paying 7% would have to be priced higher than par, thus equalizing the attractiveness of the two bonds.

8. Discount Bond: A bond that is issued less than its face value is termed as the discount bond. It does not necessarily signify that the investors get a better yield than the normal market.

To be continued............