Investing Tips Information

Bonds – Understanding the Basics
By Brian Ullitz

Bonds can be a good investment if you have some spare cash to invest. Bonds are generally safer than stocks and pay a better return than depositing your cash in a bank account. But do you understand the basics of bonds? Continue reading and you will learn what the basic terms mean.

The bond issuer is the entity who needs to borrow money and therefore has issued the bond. It can be any of various different organizations, but is most likely either a government agency or a company. Government bonds are usually safer than company bonds as there is very little risk of the issuer defaulting on the bond.

The par value, or nominal value, of a bond is the amount of money the issuer of the bond is borrowing from the purchaser of the bond. Each bond is often issued for $1,000 in the United States.

The coupon rate is the interest the bond is issued with. If, for example, the nominal interest rate is 5% on a bond with a nominal value of $1,000, you will receive $50 in interest every year. The nominal interest rate of a bond will stay the same until the bond is due.

The maturity date of a bond is the date the bond is completely repaid. Most bonds are issued for a number of years so the due date could be many years into the future. The length of time until the maturity date can be referred to as the term of the bond.

The issue price is the price you pay for the bond at the time it issued. It could be different from the par value of the bond and would most often be below the par value.

The market value is related to the par value, but is very likely different from it. Many bonds are traded on an exchange at a different price than when the bond was issued. This is the price at which the bond market trades the bond currently. If the bond value is less than the par value, the current yield will be higher than the coupon rate. The market value of the $1,000 bond might be trading at only $950.

The current yield is the interest you receive from owning the bond, calculated as a percentage. If the current interest rate level is different from when the bond was issued, the effective interest rate will be different too. The only time the coupon interest rate is equal to the current yield is when the market value is exactly equal to the par value. Then the bond is said to be traded at par value. In the example, the effective interest rate might be 5.5%.

Understanding these terms is essential if you want to understand your bond investments and what influence they have on your results.

Brian Ullitz, personal finance expert, author of the e-book Enjoy Healthy Personal Finances and founder of http://Finance4Everyone.org. If you find finances complicated, boring or intimidating get our free e-book now by enlisting to our newsletter. With this e-book you can learn to manage your debt, save money and enjoy a happier life.