Basic Corporate Bond Terms
Issuance Form. Corporate bonds are issued in several forms:
- Registered bonds. Some corporate bonds are issued as certificates, with the owner’s name printed on them. There are no coupons attached for the owner to submit for payment of interest. The issuer’s agent or trustee sends the interest to the bondholder at the proper intervals, and forwards the principal at maturity.
- Bearer bonds. These are bonds that have no name printed on them, and have coupons attached. Anonymous and highly negotiable, bearer bonds are virtually equivalent to cash. The Tax Reform Act of 1982 ended the issuance of such bonds in the United States, but some remain in circulation today.
- Book-entry bonds. The most common form of issuance today, these are bonds for which certificates are not available to investors. With book-entry securities, a bond issue has, generally, only one master, or global, certificate, which is kept at a securities depository. The investor’s ownership of book-entry bonds is recorded in the investor’s brokerage account. The broker, in turn, holds a corresponding interest in the global certificate that is held by the depository. All interest and principal payments are forwarded to the depository, and from there to the brokerage account.
Maturity. One key feature of any bond is its maturity, the date until which the bond pays interest and on which it repays the principal.
- Short-term notes: Maturities of up to 5 years
- Medium-term notes/bonds: Maturities of 5–12 years
- Long-term bonds: Maturities greater than 12 years
Interest Rate Type. Another important feature of a bond is its structure. In a traditional bond structure, a specified amount of money is lent to the issuer for a specified period of time. In exchange, the issuer makes interest payments on a regular schedule for the life of the bond, with the full principal returned at maturity. The three types of interest rates that are the most common are:
- Fixed-rate. Most bonds still pay a traditional fixed interest rate, where a bond’s interest rate is fixed to maturity.
- Floating-rate. Some bonds pay an interest rate that varies and is typically adjusted periodically according to an index tied to short-term Treasury bills or money markets. Such bonds offer protection against future increases in interest rates, and in exchange their yields are typically lower than those of comparable fixed-rate bonds.
- Zero-coupon. These bonds that have no periodic interest payments. Instead, they are sold at a deep discount to face value, and redeemed for the full face value at maturity, with the difference between that discount and the full face value representing the interest amount.
Yield. Yield is the rate of return on your bond investment. Yields vary to reflect the price movements in a bond caused by changes in prevailing interest rates, among other factors.
- Current yield. The current yield is the annual return on the dollar amount paid for a bond, regardless of its maturity. If you buy a bond at par, the current yield equals its stated interest rate. Thus, the current yield on a par-value bond paying 6% is 6%.
- However, if the market price of the bond is more or less than par, the current yield will be different. For example, if you buy a $1,000 bond with a 6% stated interest rate after prevailing interest rates have risen above that level, you would pay less than par. Assuming your price is $900, for example, the current yield would be 6.67% ($1,000 x .06/$900).
- Yield to maturity. A more meaningful figure is the yield to maturity, which tells you the total return you will receive if you hold a bond until maturity. It also enables you to compare bonds with different maturities and coupons. Yield to maturity includes all your interest to be received until maturity plus any capital gain you will realize (if you purchase the bond below par) or minus any capital loss you will suffer (if you purchase the bond above par) at maturity.
- Yield to call. The yield to call tells you the total return you would receive if you were to buy and hold the security until the call date. As an investor, you should be aware that this yield is valid only if the bond is called prior to maturity. The calculation of yield to call is based on the coupon rate, the length of time to the call date, and the market price of the bond.
Yield calculations can be obtained from your financial advisor or calculated on online resources such as investinginbonds.com.