Bond Glossary

Here’s a helpful guide to common bond terms.

Accrued interest

Interest deemed to be earned on a security but not yet paid to the investor.

Advance refunding

A financing structure under which new bonds are issued to repay an outstanding bond issue prior to its first call date. Generally, the proceeds of the new issue are invested in government securities, which are placed in escrow. The interest and principal repayments on these securities are then used to repay the old issue, usually on the first call date.

Ask price

The price at which a seller offers to sell a security (also referred to as offer price).

Basis point

One one-hundredth (.01) of a percentage point. For example, eight percent would be equal to 800 basis points.

Bearer security

A security that is  not registered in the name of  an owner. As a result, it is presumed to be owned by the bearer or the person who holds it. Bearer securities are freely and easily negotiable, since ownership can be quickly transferred from seller to buyer.

Bid price

The price at which a buyer offers to purchase a security.

Bond fund

An investment vehicle which invests in a portfolio of bonds that is professionally managed. Types of bond funds include open-ended mutual funds, closed-end mutual funds, and exchange traded funds.

Bond swap

The sale of a block of bonds and the purchase of another block of similar market value. Swaps may be made to achieve many goals, including establishing a tax loss, upgrading credit quality, extending or shortening maturity, etc.

Book-entry

A method of recording and transferring ownership of securities electronically, eliminating the need for physical certificates.

Call

A one-way option of the issuer (not the investor) that allows the issuer to retire bonds by paying investors a stated price, usually a premium above the par value. Many high-yield bonds allow issuers to call bonds after the first five years.

Callable bonds

Bonds that are redeemable by the issuer prior to the specified maturity date at a specified price at or above par.

Call premium

The dollar amount over par that an issuer pays to an investor when a bond is called for redemption prior to maturity. Usually stated as a percentage of the principal amount called.

Cap

The maximum interest rate that may be paid on a floating-rate security.

Closed-end fund

A fund created with a fixed number of shares which are traded as listed securities on a stock exchange.

Collar

Upper and lower limits (cap and floor, respectively) on the interest rate of a floating-rate security.

Collateral

Assets pledged by a borrower to secure repayment of a loan or bond.

Compound interest

Interest that is calculated on the initial principal and previously paid interest. Conver t ible bond. A corporate bond that can be exchanged, at the option of the holder, for a specific number of shares of the company’s stock.  Because a convertible bond is essentially a bond with a stock option built into it, it will usually offer a lower than prevailing rate of return.

Coupon

This  is the amount of interest due and the date on which payment is to be made. In the case of registered coupons (see “Registered bond”), the interest payment is mailed directly to the registered holder. Bearer coupons are presented to the issuer’s designated paying agent or deposited in a commercial bank for collection. Coupons are generally payable semiannually.

Credit rating

A formal evaluation of a company’s financial health and ability to repay debt obligations, conducted by a rating agency such as Standard & Poor’s, Moody’s and Fitch Ratings. The agency’s evaluation is summarized in a rating, such as BB.

Credit rating agency

A company that analyzes the credit worthiness of a company or security, and indicates that credit quality by means of a grade, or credit rating.

Current yield

The ratio of the interest rate payable on a bond to the actual market price of the bond, stated as a percentage. For example, a bond with a current market price of par ($1,000) that pays eight percent ($80) per year in interest would have a current yield of eight percent.

Current refunding

A financing structure under which old bonds are called or mature within 90 days of the issuance of new refunding bonds.

Current yield (CY)

A calculation of the annual interest payment from a bond divided by the current market price of the bond.

CUSIP

The Committee on Uniform Security Identification Procedures, which was established under the auspices of the American Bankers Association to develop a uniform method of identifying municipal, U.S. government, and corporate securities.  When issued, each bond is assigned a unique CUSIP number consisting of nine alphanumeric characters.

Dated date (or issue date)

The date of a bond issue from which the bondholder is entitled to receive interest, even though the bonds may actually be delivered at some other date.

Default

A borrower’s failure to make timely payments of interest and principal when due or to meet other requirements related to the bonds, such as maintenance of collateral or financial covenants.

Discount

The amount by which the par value of a security exceeds its purchase price. For example, a $1,000 par amount bond which is currently valued at $980 would be said to be trading at a two percent discount.

Discount note

Short-term obligations issued at a discount from face value, with maturities ranging from one to 360 days. Discount notes have no periodic interest payments; the investor receives the note’s face value at maturity. For example, a one year, $1,000 face value discount note purchased at issue at a price of $950, would yield $50 or 5.26 percent ($50/$950).

Discount rate

The interest rate the Federal Reserve charges on loans to member banks.

Double exemption

Bonds that are exempt from both state and  federal income taxes.

Duration

The weighted maturity of a bond’s cash flows, used in the estimation of its price sensitivity for a given change in interest rates.

Extraordinary redemption

This redemption is different from optional redemption or mandatory redemption in that it occurs under an unusual circumstance such as destruction of the facility financed.

Face amount

The par value (i.e., principal or maturity value) of a security appearing on the face of the instrument.

Fixed-rate bond

A long-term bond with an interest rate fixed to maturity

Federal Funds Rate

The interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.  The target federal funds rate is set by the Federal Reserve Board’s Federal Open Market Committee and is a principal tool of monetary policy. For more information, see http://www.federalreserve.gov/fomc/fundsrate.htm.

Floating-rate bond

A bond whose interest rate is adjusted periodically according to a predetermined formula; it is usually linked to an interest rate index such as LIBOR.

Floor

The lower limit for the interest rate on a floating rate bond.

Future Value

The value of an asset at a specified date in the future, calculated using a specified rate of return.

High-yield bond (or junk bond)

Bonds rated Ba1 or BB+ or below, whose lower credit ratings indicate a higher risk of default.  Due to the increased risk of default, typically issued at a higher yield than more creditworthy bonds.

Investment-grade bond (or high grade bond)

Bonds rated Baa3 or BBB- or above, whose higher credit ratings indicate a lower risk of default.  These bonds tend to issue at lower yields than less creditworthy bonds.

Interest

The amount of compensation charged by an investor for the use of assets, generally expressed as a percentage rate of par.

Issuer

The entity obligated to pay principal and interest on a bond it issues.

Legal opinion

A letter from a law firm concerning the validity of a municipal bond  with respect to statutory authority, constitutionality, procedural conformity and usually the exemption of interest from federal income taxes. The legal opinion is usually rendered by a law firm recognized as specializing in public borrowings, often referred to as “bond counsel.”

LIBOR (London Interbank Offered Rate)

The rate banks charge each other for short-term eurodollar loans. LIBOR is frequently used as the base for resetting rates on floating-rate securities.

Limited tax bond

A bond secured by a pledge of a tax or category of taxes limited as to rate or amount.

Liquidity or Marketability

A measure of the relative ease and speed with which a security can be purchased or sold in a secondary market.

Marketability

A measure of the ease with which a security can be sold.

Maturity

The date when the principal amount of a security is due to be repaid. Also the end of the life of a security.

Moral obligation bond

A revenue bond which, in addition to its primary source of security, possesses a structure whereby an issuer pledges to make up shortfalls in a debt service reserve fund, subject to legislative appropriation. While the issuer does not have a legal obligation to make such a payment, the failure of the issuer to honor the moral pledge would have negative consequences for its  creditworthiness.

Non-callable bond

A bond that cannot be called for redemption by the issuer before its specified maturity date.

Notes

Short-term bonds to pay specified amounts of money, secured by specified sources of future revenues, such as taxes, federal and state aid payments and bond proceeds.

Offer price (or ask; asking price)

The price at which members of an underwriting syndicate for a new issue will offer securities to investors.

Official statement

The disclosure document prepared by the issuer that gives in detail security and financial information about the issuer and the bonds or notes.

Optional redemption

A right of the issuer, at its option, to retire all or part of an issue prior to the stated maturity during a specified period of years, often at a premium.

Original issue discount

A bond, issued at a dollar price less than par which qualifies for special treatment under federal tax law. Under that law, the difference between the issue price and par is treated as tax-exempt income rather than a capital gain, if the bonds are held to maturity.

Par value

The principal amount of a bond due at maturity.

Paying agent

The entity, usually a designated bank or the office of the treasurer of the issuer, that pays the principal and interest of a bond.

Premium

The amount by which the price of a bond exceeds its principal amount.

Present  value

The current value of a future payment or stream of payments, given a specified interest rate, also referred to as a discount rate.

Primary market

The market for new issues.

Principal

The face amount of a bond, exclusive of accrued interest and payable at maturity (see par value).

Ratings

Designations used by credit rating agencies to give relative indications as to opinions of credit quality.

Recession

A downturn in economic activity on a large scale, such as in the U.S. economy. The Commerce Department defines a recession as two or more quarters of decline in output, as measured by Gross National Product (GNP) or Gross Domestic Product (GDP).

Recovery rate

The percentage of money recovered from the original bond in the case of an issuer default.

Registered bond

A bond whose owner is registered with the issuer or its agent. Transfer of ownership can only be accomplished if the bonds are properly endorsed by the registered owner.

Reinvestment risk

The risk that interest income or principal repayments will have to be reinvested at lower rates in a declining rate environment.

Risk

The measurable probability that an actual return will be different than expected. There are many types of risk such as market risk, credit risk, interest rate risk, exchange rate, liquidity risk, and political risk.

Secondary market

Market for issues previously offered or sold.

Secured bond

A bond that is backed by collateral.

Security

Collateral pledged by a bond issuer (debtor) to an investor (lender) to secure repayment of the loan.

Settlement date

The date for the delivery of bonds and payment of funds agreed to in a transaction.

Sinking fund

Money set aside by an issuer of bonds on a regular basis, for the specific purpose of redeeming debt. Bonds with such a feature are known as “sinkers.”

Special tax bond

A bond secured by a special tax, such as a gasoline tax.

Subordinated bond

A bond that has a lower priority than another bond’s claim to the same assets.

Total return

A measure of bond investment return that includes both interest and price change. The total return on investments is generally expressed as an annualized rate, and it assumes reinvestment of all interest back into the investment.

Trade date

The date upon which a bond is purchased or sold.

Transfer agent

The party appointed by an issuer to maintain records of bondholders, to cancel and issue certificates, and to address issues arising from lost, destroyed or stolen certificates.

Trustee

An entity designated by the issuer as the custodian of funds and official representative of bondholders. Trustees are appointed to ensure compliance with the trust indenture and represent bondholders to enforce their contract with the issuers.

Unlimited tax bond

A bond secured by the pledge of taxes that are not limited by rate or amount.

Variable rate bond

A long-term bond the interest rate of which is adjusted periodically, typically based upon specific market indicators.

Volatility

The propensity of a security’s price to rise or fall sharply.

Unsecured bond

A bond that is not secured by collateral.

Yield

The annual percentage rate of return earned on a bond calculated by dividing the coupon interest rate by its purchase price.

Yield curve

A line tracing relative yields on a type of bond over a spectrum of maturities ranging from three months to 30 years.

Yield to call

The yield on a bond calculated by dividing the value all interest payments that will be paid until the call date, plus interest on interest, by the principal amount received on the call date at the call price, taking into consideration whatever gain or loss is realized from the bond at the call date.

Example: You pay $900 for a 5 year bond with a face value of $1000. The bond pays an annual coupon of ten percent. This bond is called at year 3 for $1,100.

The yield to call of this bond is 17.4 percent. This reflects the 3 years of coupon payments and the difference between the price paid and the call price. Had the bond not been called, the yield to maturity would have been 12.8 percent.

Yield to maturity

The yield on a bond calculated by dividing the value of all the interest payments that will be paid until the maturity date, plus interest on interest, by the principal amount received at the maturity date, taking in to consideration whatever gain or loss is realized from the bond at the maturity date.

Example: You pay $900 for a 5 year bond a face value of $1000. The bond pays an annual coupon of ten percent.

Here the yield to maturity is 12.8 percent. This reflects the coupon payments and the difference between the price and the face value of the bond.

Zero-coupon bond

A bond for which no periodic interest payments are made. The investor receives one payment at maturity. The maturity value an investor receives is equal to the principal invested plus interest earned compounded semiannually at the original interest rate to maturity. (See “Discount note.”)

Talk to an HJ Sims Income Advisor Today
Follow HJ Sims
Facebook Twitter LinkedIn
top image
Are you generating enough income to reach your goals?

Free Bond Portfolio Analysis