In finance Finance is the science of funds management. The general areas of finance are business finance, personal finance, and public finance. Finance includes saving money and often includes lending money. The field of finance deals with the concepts of time, money, and risk and how they are interrelated. It also deals with how money is spent and budgeted, a bond is a debt security A security is a fungible, negotiable instrument representing financial value. Securities are broadly categorized into debt securities and equity securities, e.g., common stocks; and derivative contracts, such as forwards, futures, options and swaps. The company or other entity issuing the security is called the issuer. A country's regulatory, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest Interest is a fee paid on borrowed assets. It is the price paid for the use of borrowed money, or, money earned by deposited funds. Assets that are sometimes lent with interest include money, shares, consumer goods through hire purchase, major assets such as aircraft, and even entire factories in finance lease arrangements. The interest is (the coupon The coupon or coupon rate of a bond is the amount of interest paid per year expressed as a percentage of the face value of the bond. It is the interest rate that a bond issuer will pay to a bondholder) and/or to repay the principal at a later date, termed maturity In finance, maturity or maturity date refers to the final payment date of a loan or other financial instrument, at which point the principal is due to be paid. A bond is a formal contract to repay borrowed money with interest at fixed intervals.^[1]

Thus a bond is like a loan A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower: the issuer is the borrower (debtor), the holder is the lender (creditor), and the coupon is the interest. Bonds provide the borrower with external funds to finance long-term investments Investment is the commitment of money or capital to purchase financial instruments or other assets in order to gain profitable returns in form of interest, income, or appreciation of the value of the instrument. It is related to saving or deferring consumption. Investment is involved in many areas of the economy, such as business management and, or, in the case of government bonds, to finance current expenditure. Certificates of deposit A certificate of deposit or CD is a time deposit, a financial product commonly offered to consumers by banks, thrift institutions, and credit unions (CDs) or commercial paper In the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is a money-market security issued by large banks and corporations to get money to meet short term debt obligations (for example, payroll), and is only backed by an issuing bank or corporation's promise to pay the are considered to be money market The money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit, federal funds, and short-lived mortgage- and asset- instruments and not bonds. Bonds must be repaid at fixed intervals over a period of time.

Bonds and stocks The stock or capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors. Stock is distinct from the property and the assets of a business which may fluctuate in are both securities A security is a fungible, negotiable instrument representing financial value. Securities are broadly categorized into debt securities and equity securities, e.g., common stocks; and derivative contracts, such as forwards, futures, options and swaps. The company or other entity issuing the security is called the issuer. A country's regulatory, but the major difference between the two is that stockholders have an equity stake in the company (i.e., they are owners), whereas bondholders have a creditor stake in the company (i.e., they are lenders). Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is a consol bond Consol is a form of British government bond (gilt), dating originally from the 18th century. The first consols were originally issued in 1751. Consols are one of the rare examples of an actual perpetuity: although they may be redeemed by the British government, they are unlikely to do so in the foreseeable future, which is a perpetuity A perpetuity is an annuity that has no definite end, or a stream of cash payments that continues forever. There are few actual perpetuities in existence (the United Kingdom government has issued them in the past; these are known and still trade as consols). A number of types of investments are effectively perpetuities, such as real estate and (i.e., bond with no maturity).

Issuing bonds

Bonds are issued by public authorities, credit institutions, companies and supranational Supranationalism is a method of decision-making in multi-national political communities, wherein power is transferred or delegated to an authority by governments of member states. The authority, subject to supranational democratic institutions and with a legal procedure can therefore institute a supranational rule of law above the constituent institutions in the primary markets The primary market is that part of the capital markets that deals with the issuance of new securities. Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue. This is typically done through a syndicate of securities dealers. The process of selling new issues to investors is called. The most common process of issuing bonds is through underwriting Underwriting refers to the process that a large financial service provider uses to assess the eligibility of a customer to receive their products (equity capital, insurance, mortgage, or credit). The name derives from the Lloyd's of London insurance market. Financial bankers, who would accept some of the risk on a given venture (historically a sea. In underwriting, one or more securities firms or banks, forming a syndicate The word syndicate comes from the French word syndicat which means trade union , from the Latin word syndicus which in turn comes from the Greek word σύνδικος (syndikos) which means caretaker of an issue, compare to ombudsman or representative, buy an entire issue of bonds from an issuer and re-sell them to investors. The security firm takes the risk of being unable to sell on the issue to end investors. Primary issuance is arranged by bookrunners In investment banking, a bookrunner is usually the main underwriter or lead-manager/arranger/coordinator in equity, debt, or hybrid securities issuances. The bookrunner usually syndicates with other investment banks in order to lower its risk. The bookrunner is listed first among all underwriters participating in the issuance. When more than one who arrange the bond issue, have the direct contact with investors and act as advisors to the bond issuer in terms of timing and price of the bond issue. The bookrunners willingness to underwrite must be discussed prior to opening books on a bond issue as there may be limited appetite to do so.

In the case of Government Bonds, these are usually issued by auctions, where both members of the public and banks may bid for bond. Since the coupon is fixed, but the prices is not, the % return is a function both of the price paid as well as the coupon.^[2]

Features of bonds

The most important features of a bond are:

• nominal, principal or face amount — the amount on which the issuer pays interest, and which, most commonly, has to be repaid at the end. Some structured bonds can have a redemption amount which is different to the face amount and can be linked to performance of particular assets such as a stock or commodity index, foreign exchange rate or a fund. This can result in an investor receiving less or more than his original investment at maturity.
• issue price — the price at which investors buy the bonds when they are first issued, which will typically be approximately equal to the nominal amount. The net proceeds that the issuer receives are thus the issue price, less issuance fees.
• maturity In finance, maturity or maturity date refers to the final payment date of a loan or other financial instrument, at which point the principal is due to be paid date — the date on which the issuer has to repay the nominal amount. As long as all payments have been made, the issuer has no more obligation to the bond holders after the maturity date. The length of time until the maturity date is often referred to as the term or tenor or maturity of a bond. The maturity can be any length of time, although debt securities with a term of less than one year are generally designated money market instruments rather than bonds. Most bonds have a term of up to thirty years. Some bonds have been issued with maturities of up to one hundred years, and some even do not mature at all. In early 2005, a market developed in euros The euro is the official currency of the Eurozone: 16 of the 27 Member States of the European Union (EU) and is the currency used by the EU institutions. The eurozone consists of Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain. Estonia is due to for bonds with a maturity of fifty years. In the market for U.S. Treasury securities, there are three groups of bond maturities:
  • short term (bills): maturities up to one year;
  • medium term (notes): maturities between one and ten years;
  • long term (bonds): maturities greater than ten years.
• coupon The coupon or coupon rate of a bond is the amount of interest paid per year expressed as a percentage of the face value of the bond. It is the interest rate that a bond issuer will pay to a bondholder — the interest rate that the issuer pays to the bond holders. Usually this rate is fixed throughout the life of the bond. It can also vary with a money market index, such as LIBOR The London Interbank Offered Rate is a daily reference rate based on the interest rates at which banks borrow unsecured funds from other banks in the London wholesale money market (or interbank market), or it can be even more exotic. The name coupon originates from the fact that in the past, physical bonds were issued which had coupons attached to them. On coupon dates the bond holder would give the coupon to a bank in exchange for the interest payment.

• The "quality" of the issue refers to the probability that the bondholders will receive the amounts promised at the due dates. This will depend on a wide range of factors.
  • Indentures and Covenants — An indenture An Indenture is a legal contract reflecting a debt or purchase obligation, specifically referring to two types of practices: in historical usage, an indentured servant status, and in modern usage, an instrument used for commercial debt or real estate transaction is a formal debt agreement that establishes the terms of a bond issue, while covenants are the clauses of such an agreement. Covenants specify the rights of bondholders and the duties of issuers, such as actions that the issuer is obligated to perform or is prohibited from performing. In the U.S., federal and state securities and commercial laws apply to the enforcement of these agreements, which are construed by courts as contracts between issuers and bondholders. The terms may be changed only with great difficulty while the bonds are outstanding, with amendments to the governing document generally requiring approval by a majority (or super-majority) vote of the bondholders.
  • High yield bonds In finance, a high yield bond is a bond that is rated below investment grade at the time of purchase. These bonds have a higher risk of default or other adverse credit events, but typically pay higher yields than better quality bonds in order to make them attractive to investors are bonds that are rated below investment grade by the credit rating agencies A credit rating agency is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings. In most cases, the issuers of securities are companies, special purpose entities, state and local governments, non-. As these bonds are more risky than investment grade bonds, investors expect to earn a higher yield. These bonds are also called junk bonds In finance, a high yield bond is a bond that is rated below investment grade at the time of purchase. These bonds have a higher risk of default or other adverse credit events, but typically pay higher yields than better quality bonds in order to make them attractive to investors.
• coupon dates — the dates on which the issuer pays the coupon to the bond holders. In the U.S. and also in the U.K. and Europe, most bonds are semi-annual, which means that they pay a coupon every six months.
• Optionality: Occasionally a bond may contain an embedded option; that is, it grants option-like In finance, an option is a type of financial instrument classed as derivatives because they derive their value from an underlying asset. An option gives its holder the right, but not the obligation, to buy or to sell some asset on or before the option's expiration at an agreed price, the strike price features to the holder or the issuer:
  • Callability — Some bonds give the issuer the right to repay the bond before the maturity date on the call dates; see call option The buyer of a call option wants the price of the underlying instrument to rise in the future; the seller either expects that it will not, or is willing to give up some of the upside from a price rise in return for the premium (paid immediately) and retaining the opportunity to make a gain up to the strike price (see below for examples). These bonds are referred to as callable bonds A callable bond is a type of bond] (debt security) that allows the issuer of the bond to retain the privilege of redeeming the bond at some point before the bond reaches the date of maturity. In other words, on the call date(s), the issuer has the right, but not the obligation, to buy back the bonds from the bond holders at a defined call price. Most callable bonds allow the issuer to repay the bond at par Par value, in finance and accounting, means stated value or face value. From this comes the expressions at par , over par (over par value) and under par (under par value). With some bonds, the issuer has to pay a premium, the so called call premium. This is mainly the case for high-yield bonds. These have very strict covenants, restricting the issuer in its operations. To be free from these covenants, the issuer can repay the bonds early, but only at a high cost.
  • Putability — Some bonds give the holder the right to force the issuer to repay the bond before the maturity date on the put dates; see put option A put option is a financial contract between two parties, the writer (seller) and the buyer of the option. The buyer acquires a short position with the right, but not the obligation, to sell the underlying instrument at an agreed-upon price (the strike price). If the buyer exercises his right to sell the option, the seller is obliged to buy it at. (Note: "Putable" denotes an embedded put option; "Puttable" denotes that it may be putted Golf stroke mechanics is the means by which golfers make decisions and execute them (making shots) in the sport of golf. For all golfers, it consists of a pre-stroke: (in which golfer choose which club they want and their stance) and the actual stroke.)
  • call dates and put dates—the dates In finance, the style or family of an option is a general term denoting the class into which the option falls, usually defined by the dates on which the option may be exercised. The vast majority of options are either European or American options. These options - as well as others where the payoff is calculated similarly - are referred to as " on which callable and putable bonds can be redeemed early. There are four main categories.
    • A Bermudan callable has several call dates, usually coinciding with coupon dates.
    • A European callable has only one call date. This is a special case of a Bermudan callable.
    • An American callable can be called at any time until the maturity date.
    • A death put is an optional redemption feature on a debt instrument allowing the beneficiary of the estate of the deceased to put (sell) the bond (back to the issuer) in the event of the beneficiary's death or legal incapacitation. Also known as a "survivor's option".
• sinking fund provision of the corporate bond indenture requires a certain portion of the issue to be retired periodically. The entire bond issue can be liquidated by the maturity date. If that is not the case, then the remainder is called balloon maturity. Issuers may either pay to trustees, which in turn call randomly selected bonds in the issue, or, alternatively, purchase bonds in open market, then return them to trustees.
• convertible bond In finance, a convertible note is a type of bond that the holder can convert into shares of common stock in the issuing company or cash of equal value, at an agreed-upon price. It is a hybrid security with debt- and equity-like features. Although it typically has a low coupon rate, the instrument carries additional value through the option to lets a bondholder exchange a bond to a number of shares of the issuer's common stock.
• exchangeable bond In finance, an exchangeable bond is a straight bond with an embedded option to exchange the bond for the stock of a company other than the issuer (usually a subsidiary or company in which the issuer owns a stake) at some future date and under prescribed conditions. An exchangeable bond is different from a convertible bond. A convertible bond gives allows for exchange to shares of a corporation other than the issuer.

Types of bonds

The following descriptions are not mutually exclusive, and more than one of them may apply to a particular bond.

• Fixed rate bonds In finance, a fixed rate bond is a bond with a fixed coupon rate, as opposed to a floating rate note. A fixed rate bond is a long term debt paper that carries a predetermined interest rate. The interest rate is known as coupon rate and interest is payable at specified dates before bond maturity have a coupon that remains constant throughout the life of the bond.

• Floating rate notes Floating rate notes are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a spread. The spread is a rate that remains constant. Almost all FRNs have quarterly coupons, i.e. they pay out interest every three months, though counter examples do exist. At the beginning of each coupon (FRNs) have a variable coupon that is linked to a reference rate A reference rate is a rate that determines pay-offs in a financial contract and that is outside the control of the parties to the contract. It is often some form of LIBOR rate, but it can take many forms, such as a consumer price index, a house price index or an unemployment rate. Parties to the contract choose a reference rate that neither party of interest, such as LIBOR The London Interbank Offered Rate is a daily reference rate based on the interest rates at which banks borrow unsecured funds from other banks in the London wholesale money market (or interbank market) or Euribor The Euro Interbank Offered Rate is a daily reference rate based on the averaged interest rates at which banks offer to lend unsecured funds to other banks in the euro wholesale money market (or interbank market). For example the coupon may be defined as three month USD LIBOR + 0.20%. The coupon rate is recalculated periodically, typically every one or three months.

• Zero-coupon bonds A zero-coupon bond is a bond bought at a price lower than its face value, with the face value repaid at the time of maturity. It does not make periodic interest payments, or have so-called "coupons," hence the term zero-coupon bond. Investors earn return from the compounded interest all paid at maturity plus the difference between the pay no regular interest. They are issued at a substantial discount to par value Par value, in finance and accounting, means stated value or face value. From this comes the expressions at par , over par (over par value) and under par (under par value), so that the interest is effectively rolled up to maturity (and usually taxed as such). The bondholder receives the full principal amount on the redemption date. An example of zero coupon bonds is Series E savings bonds issued by the U.S. government. Zero-coupon bonds A zero-coupon bond is a bond bought at a price lower than its face value, with the face value repaid at the time of maturity. It does not make periodic interest payments, or have so-called "coupons," hence the term zero-coupon bond. Investors earn return from the compounded interest all paid at maturity plus the difference between the may be created from fixed rate bonds by a financial institution separating "stripping off" the coupons from the principal. In other words, the separated coupons and the final principal payment of the bond may be traded separately. See IO (Interest Only) and PO (Principal Only).

• Inflation linked bonds Inflation-indexed bonds are bonds where the principal is indexed to inflation. They are thus designed to cut out the inflation risk of an investment. The first known inflation-indexed bond was issued by the Massachusetts Bay Company in 1780. The market has grown dramatically since the British government began issuing inflation-linked Gilts in 1981, in which the principal amount and the interest payments are indexed to inflation. The interest rate is normally lower than for fixed rate bonds with a comparable maturity (this position briefly reversed itself for short-term UK bonds in December 2008). However, as the principal amount grows, the payments increase with inflation. The United Kingdom The United Kingdom of Great Britain and Northern Ireland[note 7] is a sovereign state located off the northwestern coast of continental Europe. It is an island country, spanning an archipelago including Great Britain, the northeastern part of the island of Ireland, and many small islands. Northern Ireland is the only part of the UK with a land was the first sovereign issuer to issue inflation linked Gilts Gilts are bonds issued by the governments of the United Kingdom, South Africa, or Ireland. The term is of British origin, and refers to the debt securities issued by the Bank of England, which had a gilt edge. Hence, they are called gilt-edged securities, or gilts for short. Generally, when a market participant refers to gilts, what is meant is in the 1980s. Treasury Inflation-Protected Securities A United States Treasury security is government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt. Treasury securities are the debt financing instruments of the United States Federal government, and they are often referred to simply as Treasuries. There are four types of marketable treasury (TIPS) and I-bonds are examples of inflation linked bonds issued by the U.S. government.

• Other indexed bonds, for example equity-linked notes and bonds indexed on a business indicator (income, added value) or on a country's GDP.

• Asset-backed securities are bonds whose interest and principal payments are backed by underlying cash flows from other assets. Examples of asset-backed securities are mortgage-backed securities (MBS's), collateralized mortgage obligations (CMOs) and collateralized debt obligations (CDOs).

• Subordinated bonds are those that have a lower priority than other bonds of the issuer in case of liquidation. In case of bankruptcy, there is a hierarchy of creditors. First the liquidator is paid, then government taxes, etc. The first bond holders in line to be paid are those holding what is called senior bonds. After they have been paid, the subordinated bond holders are paid. As a result, the risk is higher. Therefore, subordinated bonds usually have a lower credit rating than senior bonds. The main examples of subordinated bonds can be found in bonds issued by banks, and asset-backed securities. The latter are often issued in tranches. The senior tranches get paid back first, the subordinated tranches later.

• Perpetual bonds are also often called perpetuities or 'Perps'. They have no maturity date. The most famous of these are the UK Consols, which are also known as Treasury Annuities or Undated Treasuries. Some of these were issued back in 1888 and still trade today, although the amounts are now insignificant. Some ultra-long-term bonds (sometimes a bond can last centuries: West Shore Railroad issued a bond which matures in 2361 (i.e. 24th century)) are virtually perpetuities from a financial point of view, with the current value of principal near zero.

• Bearer bond is an official certificate issued without a named holder. In other words, the person who has the paper certificate can claim the value of the bond. Often they are registered by a number to prevent counterfeiting, but may be traded like cash. Bearer bonds are very risky because they can be lost or stolen. Especially after federal income tax began in the United States, bearer bonds were seen as an opportunity to conceal income or assets.^[3] U.S. corporations stopped issuing bearer bonds in the 1960s, the U.S. Treasury stopped in 1982, and state and local tax-exempt bearer bonds were prohibited in 1983.^[4]

• Registered bond is a bond whose ownership (and any subsequent purchaser) is recorded by the issuer, or by a transfer agent. It is the alternative to a Bearer bond. Interest payments, and the principal upon maturity, are sent to the registered owner.

• Pacific Railroad Bond issued by City and County of San Francisco, CA. May 1, 1865 Municipal bond is a bond issued by a state, U.S. Territory, city, local government, or their agencies. Interest income received by holders of municipal bonds is often exempt from the federal income tax and from the income tax of the state in which they are issued, although municipal bonds issued for certain purposes may not be tax exempt.

• Book-entry bond is a bond that does not have a paper certificate. As physically processing paper bonds and interest coupons became more expensive, issuers (and banks that used to collect coupon interest for depositors) have tried to discourage their use. Some book-entry bond issues do not offer the option of a paper certificate, even to investors who prefer them.^[5]

• Lottery bond is a bond issued by a state, usually a European state. Interest is paid like a traditional fixed rate bond, but the issuer will redeem randomly selected individual bonds within the issue according to a schedule. Some of these redemptions will be for a higher value than the face value of the bond.

• War bond is a bond issued by a country to fund a war.

• Serial bond is a bond that matures in installments over a period of time. In effect, a $100,000, 5-year serial bond would mature in a $20,000 annuity over a 5-year interval.

• Revenue bond is a special type of municipal bond distinguished by its guarantee of repayment solely from revenues generated by a specified revenue-generating entity associated with the purpose of the bonds. Revenue bonds are typically "non-recourse," meaning that in the event of default, the bond holder has no recourse to other governmental assets or revenues.

Bonds issued in foreign currencies

Some companies, banks, governments, and other sovereign entities may decide to issue bonds in foreign currencies as it may appear to be more stable and predictable than their domestic currency. Issuing bonds denominated in foreign currencies also gives issuers the ability to access investment capital available in foreign markets. The proceeds from the issuance of these bonds can be used by companies to break into foreign markets, or can be converted into the issuing company's local currency to be used on existing operations through the use of foreign exchange swap hedges. Foreign issuer bonds can also be used to hedge foreign exchange rate risk. Some foreign issuer bonds are called by their nicknames, such as the "samurai bond." These can be issued by foreign issuers looking to diversify their investor base away from domestic markets. These bond issues are generally governed by the law of the market of issuance, e.g., a samurai bond, issued by an investor based in Europe, will be governed by Japanese law. Not all of the following bonds are restricted for purchase by investors in the market of issuance.

• Eurodollar bond, a U.S. dollar-denominated bond issued by a non-U.S. entity outside the U.S^[6]
• Kangaroo bond, an Australian dollar-denominated bond issued by a non-Australian entity in the Australian market
• Maple bond, a Canadian dollar-denominated bond issued by a non-Canadian entity in the Canadian market
• Samurai bond, a Japanese yen-denominated bond issued by a non-Japanese entity in the Japanese market
• Shibosai Bond is a private placement bond in Japanese market with distribution limited to institutions and banks.
• Yankee bond, a US dollar-denominated bond issued by a non-US entity in the US market
• Shogun bond, a non-yen-denominated bond issued in Japan by a non-Japanese institution or government^[7]
• Bulldog bond, a pound sterling-denominated bond issued in London by a foreign institution or government
• Matrioshka bond, a Russian rouble-denominated bond issued in the Russian Federation by non-Russian entities. The name derives from the famous Russian wooden dolls, Matrioshka, popular among foreign visitors to Russia
• Arirang bond, a Korean won-denominated bond issued by a non-Korean entity in the Korean market^[8]
• Kimchi bond, a non-Korean won-denominated bond issued by a non-Korean entity in the Korean market^[9]
• Formosa bond, a non-New Taiwan Dollar-denominated bond issued by a non-Taiwan entity in the Taiwan market^[10]
• Panda bond, a Chinese renminbi-denominated bond issued by a non-China entity in the People's Republic of China market^[11]

Trading and valuing bonds

The interest rate that the issuer of a bond must pay is influenced by a variety of factors, such as current market interest rates, the length of the term and the creditworthiness of the issuer.

These factors are likely to change over time, so the market price of a bond will vary after it is issued. This price is expressed as a percentage of nominal value. Bonds are not necessarily issued at par (100% of face value, corresponding to a price of 100), but bond prices converge to par when they approach maturity (if the market expects the maturity payment to be made in full and on time) as this is the price the issuer will pay to redeem the bond. This is referred to as "Pull to Par". At other times, prices can be above par (bond is priced at greater than 100), which is called trading at a premium, or below par (bond is priced at less than 100), which is called trading at a discount. Most government bonds are denominated in units of $1000 in the United States, or in units of £100 in the United Kingdom. Hence, a deep discount US bond, selling at a price of 75.26, indicates a selling price of $752.60 per bond sold. (Often, in the US, bond prices are quoted in points and thirty-seconds of a point, rather than in decimal form.) Some short-term bonds, such as the U.S. Treasury Bill, are always issued at a discount, and pay par amount at maturity rather than paying coupons. This is called a discount bond.

The market price of a bond is the present value of all expected future interest and principal payments of the bond discounted at the bond's redemption yield, or rate of return. That relationship defines the redemption yield on the bond, which represents the current market interest rate for bonds with similar characteristics. The yield and price of a bond are inversely related so that when market interest rates rise, bond prices fall and vice versa. Thus the redemption yield could be considered to be made up of two parts: the current yield (see below) and the expected capital gain or loss: roughly the current yield plus the capital gain (negative for loss) per year until redemption.

The market price of a bond may include the accrued interest since the last coupon date. (Some bond markets include accrued interest in the trading price and others add it on explicitly after trading.) The price including accrued interest is known as the "full" or "dirty price". (See also Accrual bond.) The price excluding accrued interest is known as the "flat" or "clean price".

The interest rate adjusted for (divided by) the current price of the bond is called the current yield (this is the nominal yield multiplied by the par value and divided by the price). There are other yield measures that exist such as the yield to first call, yield to worst, yield to first par call, yield to put, cash flow yield and yield to maturity.

The relationship between yield and maturity for otherwise identical bonds is called a yield curve.A yield curve is essentially a measure of the term structure of bonds.

Bonds markets, unlike stock or share markets, often do not have a centralized exchange or trading system. Rather, in most developed bond markets such as the U.S., Japan and western Europe, bonds trade in decentralized, dealer-based over-the-counter markets. In such a market, market liquidity is provided by dealers and other market participants committing risk capital to trading activity. In the bond market, when an investor buys or sells a bond, the counterparty to the trade is almost always a bank or securities firm acting as a dealer. In some cases, when a dealer buys a bond from an investor, the dealer carries the bond "in inventory." The dealer's position is then subject to risks of price fluctuation. In other cases, the dealer immediately resells the bond to another investor.

Bond markets can also differ from stock markets in that, in some markets, investors sometimes do not pay brokerage commissions to dealers with whom they buy or sell bonds. Rather, the dealers earn revenue by means of the spread, or difference, between the price at which the dealer buys a bond from one investor -- the "bid" price -- and the price at which he or she sells the same bond to another investor--the "ask" or "offer" price. The bid/offer spread represents the total transaction cost associated with transferring a bond from one investor to another.

Investing in bonds

Bonds are bought and traded mostly by institutions like central banks, sovereign wealth funds, pension funds, insurance companies and banks. Most individuals who want to own bonds do so through bond funds. Still, in the U.S., nearly 10% of all bonds outstanding are held directly by households.

Sometimes, bond markets rise (while yields fall) when stock markets fall. More relevantly, the volatility of bonds (especially short and medium dated bonds) is lower than that of stocks. Thus bonds are generally viewed as safer investments than stocks, but this perception is only partially correct. Bonds do suffer from less day-to-day volatility than stocks, and bonds' interest payments are often higher than the general level of dividend payments. Bonds are liquid – it is fairly easy to sell one's bond investments, though not nearly as easy as it is to sell stocks – and the comparative certainty of a fixed interest payment twice per year is attractive. Bondholders also enjoy a measure of legal protection: under the law of most countries, if a company goes bankrupt, its bondholders will often receive some money back (the recovery amount), whereas the company's stock often ends up valueless. However, bonds can also be risky:

• Fixed rate bonds are subject to interest rate risk, meaning that their market prices will decrease in value when the generally prevailing interest rates rise. Since the payments are fixed, a decrease in the market price of the bond means an increase in its yield. When the market interest rate rises, the market price of bonds will fall, reflecting investors' ability to get a higher interest rate on their money elsewhere — perhaps by purchasing a newly issued bond that already features the newly higher interest rate. Note that this drop in the bond's market price does not affect the interest payments to the bondholder at all, so long-term investors who want a specific amount at the maturity date need not worry about price swings in their bonds and do not suffer from interest rate risk.

Bonds are also subject to various other risks such as call and prepayment risk, credit risk, reinvestment risk, liquidity risk, event risk, exchange rate risk, volatility risk, inflation risk, sovereign risk and yield curve risk.

Price changes in a bond will also immediately affect mutual funds that hold these bonds. If the value of the bonds held in a trading portfolio has fallen over the day, the value of the portfolio will also have fallen. This can be damaging for professional investors such as banks, insurance companies, pension funds and asset managers (irrespective of whether the value is immediately "marked to market" or not). If there is any chance a holder of individual bonds may need to sell his bonds and "cash out", interest rate risk could become a real problem. (Conversely, bonds' market prices would increase if the prevailing interest rate were to drop, as it did from 2001 through 2003.) One way to quantify the interest rate risk on a bond is in terms of its duration. Efforts to control this risk are called immunization or hedging.

• Bond prices can become volatile depending on the credit rating of the issuer - for instance if the credit rating agencies like Standard & Poor's and Moody's upgrade or downgrade the credit rating of the issuer. A downgrade will cause the market price of the bond to fall. As with interest rate risk, this risk does not affect the bond's interest payments (provided the issuer does not actually default), but puts at risk the market price, which affects mutual funds holding these bonds, and holders of individual bonds who may have to sell them.

• A company's bondholders may lose much or all their money if the company goes bankrupt. Under the laws of many countries (including the United States and Canada), bondholders are in line to receive the proceeds of the sale of the assets of a liquidated company ahead of some other creditors. Bank lenders, deposit holders (in the case of a deposit taking institution such as a bank) and trade creditors may take precedence.

There is no guarantee of how much money will remain to repay bondholders. As an example, after an accounting scandal and a Chapter 11 bankruptcy at the giant telecommunications company Worldcom, in 2004 its bondholders ended up being paid 35.7 cents on the dollar. In a bankruptcy involving reorganization or recapitalization, as opposed to liquidation, bondholders may end up having the value of their bonds reduced, often through an exchange for a smaller number of newly issued bonds.

• Some bonds are callable, meaning that even though the company has agreed to make payments plus interest towards the debt for a certain period of time, the company can choose to pay off the bond early. This creates reinvestment risk, meaning the investor is forced to find a new place for his money, and the investor might not be able to find as good a deal, especially because this usually happens when interest rates are falling.

Bond indices

A number of bond indices exist for the purposes of managing portfolios and measuring performance, similar to the S&P 500 or Russell Indexes for stocks. The most common American benchmarks are the (ex) Lehman Aggregate, Citigroup BIG and Merrill Lynch Domestic Master. Most indices are parts of families of broader indices that can be used to measure global bond portfolios, or may be further subdivided by maturity and/or sector for managing specialized portfolios.

See also

• Bond market
• Bond fund
• Bond market index
• Brady Bonds
• Build America Bonds
• Eurobond
• Bond credit rating
• Collective action clause
• Criticism of debt
• Debenture
• Deferred financing costs
• Fixed income
• Immunization (finance)
• List of accounting topics
• List of economics topics
• List of finance topics
• Short rate model
• Promissory note

References

1. ^ O'Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 197,507. ISBN 0-13-063085-3. http://www.pearsonschool.com/index.cfm?locator=PSZ3R9&PMDbSiteId=2781&PMDbSolutionId=6724&PMDbCategoryId=&PMDbProgramId=12881&level=4.
2. ^ http://www.dmo.gov.uk/index.aspx?page=Gilts/Operations
3. ^ Eason, Yla (June 6, 1983). "Final Surge in Bearer Bonds" New York Times.
4. ^ Quint, Michael (August 14, 1984). "Elements in Bearer Bond Issue". New York Times.
5. ^ no byline (July 18, 1984). "Book Entry Bonds Popular". New York Times.
6. ^ "Eurodollar deposit". http://www.riskglossary.com/link/eurodollar_deposit.htm. Retrieved 2009-01-05.
7. ^ no byline (2005-12-05). "Ninja loans may yet overtake samurais". The Standard. http://www.thestandard.hk/news_detail.asp?we_cat=10&art_id=7106&sid=5769214&con_type=1&d_str=20051205. Retrieved 2008-12-09.
8. ^ Batten, Jonathan A.; Peter G. Szilagyi (2006-04-19). "Developing Foreign Bond Markets: The Arirang Bond Experience in Korea" (PDF). IIS Discussion Papers (138). http://www.tcd.ie/iiis/documents/discussion/pdfs/iiisdp138.pdf. Retrieved 2007-07-06.
9. ^ Gwon, Yeong-seok (2006-05-24). "‘김치본드’ 내달 처음으로 선보인다 (Announcement: first 'Kimchi Bonds' next month)". The Hankyoreh. http://www.hani.co.kr/arti/economy/stock/126171.html. Retrieved 2007-07-06.
10. ^ Chung, Amber (2007-04-19). "BNP Paribas mulls second bond issue on offshore market". Taipei Times. http://www.taipeitimes.com/News/biz/archives/2007/04/19/2003357355. Retrieved 2007-07-04.
11. ^ Areddy, James T. (2005-10-11). "Chinese Markets Take New Step With Panda Bond". The Wall Street Journal. http://online.wsj.com/article/SB112893305062664267.html?mod=article-outset-box. Retrieved 2007-07-06.

External links

• Bonds links at the Open Directory Project

Categories: Bonds | Economics terminology

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