A bond is a financial instrument for indebtedness of the bond issuer to the holders. The issuer owes the holders a debt, and depending on the terms of the bond is obliged to pay them interest (the coupon) and/or to repay the principal at a later date – termed the maturity.
In simple terms, a bond is simply a form of loan: the holder of the bond is the lender (creditor), the issuer of the bond is the borrower (debtor), and the coupon is the interest.
Bonds are issued by public authorities, credit institutions, companies, and supranational institutions in the primary market. Both individuals and companies can purchase bonds.
They are among the safest investment vehicles an investor can consider. However, a shallow understanding of how they work may attenuate its attractiveness. One way of familiarising oneself with bonds is by understanding certain basic terminologies used in relation and reference to this investment instrument.
- Coupon – is the interest rate that the issuer pays to the holder. For example, a GH¢1,000 bond with a 10% coupon will pay GH¢100 annually. Earlier in time, bond certificates had coupons attached to them for interest payments. On each coupon date, the bondholder would claim the interest payment by handing over one coupon.
- Coupon dates – are the dates on which the bond issuer will make interest payments.
- Face value – is the amount paid to the bondholder at maturity and the amount the bond issuer uses when calculating interest payments.
- Par – is another name for the face value. A bond sells ‘below par’ if it trades at a discount and ‘above par’ if it trades at a premium.
- Credit quality – refers to the quality of the bond issued with respect to the probability that holders of the bond will receive their regular interest payments.
- Yield – is the return received from investing in the bond.
- Issue price – is the price at which the issuer of the bond initially sells the bond on the primary market.
- Market price – is the price at which the bond trades on the secondary market.
- Selling at a premium is the term used to describe a bond with a market price that is higher than its face value.
- Selling at a discount is the term used to describe a bond with a market price that is lower than its face value.
- Investment-grade bonds – have high credit quality and are believed to be less risky to not risky. They include some government bonds and bonds of some blue-chip companies.
- High-yield bonds – have a lower credit quality rating than investment-grade bonds, and thus offer higher interest rates in return for the increased risk. They are sometimes referred to as ‘junk bonds’.
- Corporate bonds – are simply bonds issued by private and public corporations.
- Callable Bond – is used in reference to a bond that gives the issuer an option to buy back the bond before it matures. This may be the case when interest rates are falling and an issuer wishes to finance its debt at lower rates by re-issuing new bonds, thus saving money. However, it does not necessarily mean that the bondholder will lose out; because sometimes there is an extra premium added to the face value of the bond.
- Put Bonds – Also known as puttable or retractable bonds. Put bonds have an option that affords the bondholder a chance to sell it back at face value before it matures, but at a pre-determined date.
- Convertible bonds – can be converted into stock in the company that issued them. They give the bondholder an advantage of dual option, but also usually offer lower interest rates.
- Secured bonds – are backed by collateral. With these, the issuer pledges an asset to cover the bond’s value. The asset(s) will be passed to bondholders in the event that the company goes bankrupt.
- Debentures – are unsecured bonds and are not backed by collateral but by the promise of repayment. Government bonds are usually unsecured because the government is, more often than not, deemed creditworthy.
- Municipal bonds – are bonds issued by states, cities, regions and other government entities. These are common in countries with a more rigorous decentralised system.
A licenced financial advisor can also help with more enlightenment on bonds, so do well to contact one now.
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