What are “Bond Characteristics”?
Bonds, which are a form of debt instrument, all have certain common characteristics – whether it be government bonds or corporate bonds. The most important common characteristics of a bond, relate to the bond issuer, maturity date, coupon, face value, bond price, and bond yield. Much like loans, a bond investor lends money to the issuer of the bond and the issuer promises to repay the amount at a specific date in the future – termed as the ‘maturity date’. Between the bond issue date and the maturity date, bond investors typically receive regular interest rate payments. However, bonds differ from loans, as they are easier to trade in and out of so the ownership of a bond can be sold. For most bonds, there is usually a relatively liquid secondary market.
This means that investors who lend money to the issuer of the bond, initially for a term of say 7 or 10 years in the primary market, can later decide to sell the bond to another investor in the secondary market on any business day and get their money back – even if the maturity date has not been reached.
Key Learning Points
- The most important common characteristics of a bond, relate to the bond issuer, maturity date, coupon, face value, bond price, and bond yield
- Bonds, unlike bank loans, are tradeable
Bond Characteristics – Most Common Ones
A bond is a contractual agreement between the issuer of the bond and its bondholders. The most important common characteristics vis-à-vis all bonds refer to the bond issuer, maturity date, coupon, face value, bond price, and bond yield. These common characteristics of bonds determine the scheduled cash flows of a bond. Consequently, they are the main determinants of an investor’s expected return and actual return.
Bond issuer: This is the entity or company seeking to borrow money from investors and is the entity or company that should repay the money borrowed. Therefore, the bond issuer determines the credit risk that investors will be exposed to. Sovereign governments, supranational organizations and corporate issuers amongst others can all issue bonds and are given credit ratings according to factors determined by the credit rating agencies. One issuer can have multiple credit ratings – these are attributed to each individual debt issue.
Maturity date: This is the date at which the bond will be redeemed i.e. when the outstanding principal amount is repaid back to the investor. Maturities of bonds can range from overnight to 30 years or more.
Coupon: This is the nominal rate of interest that an issuer agrees to pay to the bondholder each year until the maturity date. It is usually expressed as a percentage (%) of the face value of a bond and is almost always given as a per annum rate. For example, a bond with a coupon rate of 4% and a face value of $1,000, will pay an annual interest of $40.
Face Value (FV): This is also known as the notional or principal amount, which is the amount that will be repaid to the bondholder upon maturity. This is given as a currency amount, for example, $5 million.
Bond Price: The current market price of a bond is expressed as a percentage of face value. Bonds are tradable in the secondary market and the prices at which bonds can be bought and sold at are recorded in percentage terms. For example, a bond could have a price of 102%. Therefore, if a bond trades at a price of 102% and the investor buys a bond of $100 million face value, the current market price of the bond is $102 million.
Bond Yield: This refers to the returns an investor will derive by investing in a bond. It is calculated by dividing the annual coupon on a bond by its current market price.
Bond Yield = Annual Coupon Payment on a Bond / Bond Price
The annual coupon payment is computed by multiplying the face value of a bond with its coupon rate (%). Bond prices and bond yields have an inverse relationship. When the price of a bond goes up (down), the yield goes down (up).
Bond Yield, Example
Given below is an example of a bond that has a face value of $1,000. The coupon rate (annual) is 4%. Therefore, the annual coupon payment is $40. Now, assume that the current price of the bond is $960. Based on this information, the bond yield is now 4.2% – the yield depends entirely on the annual coupon and the price of the bond. It ignores the frequency of payment, redemption value at maturity, and the time value of money.