Bond Basics | FINRA.org

The vast majority of bonds have a set maturity date—a specific date when the bond must be paid back at its face value, called par value. Bonds are called fixed- ... Skiptomaincontent ForInvestors LearntoInvest TypesofInvestments Bonds EXPLORETHISSECTION FINRAMainNavigation ForInvestors InvestorInsights Tools&Calculators PersonalFinance LearntoInvest ProtectYourMoney FortheMilitary NeedHelp? BondBasics Tobetterunderstandbondsandbondfunds,let’sstartwithsomebasicconcepts.  What'saBond? Abondisaloanthataninvestormakestoacorporation,government,federalagencyorotherorganization.Consequently,bondsaresometimesreferredtoasdebtsecurities.Sincebondissuersknowyouaren'tgoingtolendyourhard-earnedmoneywithoutcompensation,theissuerofthebond(theborrower)entersintoalegalagreementtopayyou(thebondholder)interest.Thebondissueralsoagreestorepayyoutheoriginalsumloanedatthebond'smaturitydate,thoughcertainconditions,suchasabondbeingcalled,maycauserepaymenttobemadeearlier. Thevastmajorityofbondshaveasetmaturitydate—aspecificdatewhenthebondmustbepaidbackatitsfacevalue,calledparvalue.Bondsarecalledfixed-incomesecuritiesbecausemanypayyouinterestbasedonaregular,predeterminedinterestrate—alsocalledacouponrate—thatissetwhenthebondisissued.Similarly,theterm“bondmarket”isoftenusedinterchangeablywith"fixed-incomemarket." BondMaturity Abond'sterm,oryearstomaturity,isusuallysetwhenitisissued.Bondmaturitiescanrangefromonedayto100years,butthemajorityofbondmaturitiesrangefromoneto30years.Bondsareoftenreferredtoasbeingshort-,medium-orlong-term.Generally,abondthatmaturesinonetothreeyearsisreferredtoasashort-termbond.Medium-orintermediate-termbondsaregenerallythosethatmatureinfourto10years,andlong-termbondsarethosewithmaturitiesgreaterthan10years.Theborrowerfulfillsitsdebtobligationtypicallywhenthebondreachesitsmaturitydate,andthefinalinterestpaymentandtheoriginalsumyouloaned(theprincipal)arepaidtoyou. CallableBonds Notallbondsreachmaturity,evenifyouwantthemto.Callablebondsarecommon.Theyallowtheissuertoretireabondbeforeitmatures.Callprovisionsareoutlinedinthebond'sprospectus(orofferingstatementorcircular)andtheindenture—botharedocumentsthatexplainabond'stermsandconditions.Whilefirmsarenotformallyrequiredtodocumentallcallprovisiontermsonthecustomer'sconfirmationstatement,manydoso.Whenyoubuymunicipalsecurities,firmsarerequiredtoprovidemorecallinformationonthecustomerconfirmationthanyouwillseeforothertypesofdebtsecurities. Youusuallyreceivesomecallprotectionforaperiodofthebond'slife(forexample,thefirstthreeyearsafterthebondisissued).Thismeansthatthebondcannotbecalledbeforeaspecifieddate.Afterthat,thebond'sissuercanredeemthatbondonthepredeterminedcalldate,orabondmaybecontinuouslycallable,meaningtheissuermayredeemthebondatthespecifiedpriceatanytimeduringthecallperiod.Beforeyoubuyabond,alwayschecktoseeifthebondhasacallprovision,andconsiderhowthatmightimpactyourinvestmentstrategy. BondCoupons Abond'scouponistheannualinterestratepaidontheissuer'sborrowedmoney,generallypaidoutsemiannually.Thecouponisalwaystiedtoabond'sfaceorparvalue,andisquotedasapercentageofpar.Forinstance,abondwithaparvalueof$1,000andanannualinterestrateof4.5percenthasacouponrateof4.5percent($45). Manybondinvestorsrelyonabond'scouponasasourceofincome,spendingthesimpleinteresttheyreceive. Youcanalsoreinvesttheinterest,lettingyourinterestgaininterest.Iftheinterestrateatwhichyoureinvestyourcouponsishigherorlower,yourtotalreturnwillbemoreorless.Alsobeawarethattaxescanreduceyourtotalreturn. ThePowerofCompounding Regardlessofthetypeofinvestmentyouselect,savingregularlyandreinvestingyourinterestincomecanturnevenmodestamountsofmoneyintosizableinvestmentsthroughtheremarkablepowerofcompounding.Ifyousave$200amonthandreceivea5percentannualrateofreturn,youwillhavemorethan$82,000in20years'time. AccruedInterest Accruedinterestistheinterestthataddsup(accrues)eachdaybetweencouponpayments.Ifyousellabondbeforeitmaturesorbuyabondinthesecondarymarket,youmostlikelywillcatchthebondbetweencouponpaymentdates.Ifyou'reselling,you'reentitledtothepriceofthebond,plustheaccruedinterestthatthebondhasearneduptothesaledate.Thebuyercompensatesyouforthisportionofthecouponinterest,whichisgenerallyhandledbyaddingtheamounttothecontractpriceofthebond. UseourAccruedInterestCalculatortofigureoutabond'saccruedinterest. BondPrices Bondsaregenerallyissuedinmultiplesof$1,000,alsoknownasabond'sfaceorparvalue.Butabond'spriceissubjecttomarketforcesandoftenfluctuatesaboveorbelowpar.Ifyousellabondbeforeitmatures,youmaynotreceivethefullprincipalamountofthebondandwillnotreceiveanyremaininginterestpayments.Thisisbecauseabond'spriceisnotbasedontheparvalueofthebond.Instead,thebond'spriceisestablishedinthesecondarymarketandfluctuates.Asaresult,thepricemaybemoreorlessthantheamountofprincipalandtheremaininginteresttheissuerwouldberequiredtopayyouifyouheldthebondtomaturity. Thepriceofabondcanbeaboveorbelowitsparvalueformanyreasons,including: interestrateadjustmentstothebond; whetherabondcreditratinghaschanged; supplyanddemand; achangeinthecreditworthinessofabond'sissuer; whetherthebondhasbeencalledorislikelytobe(ornottobe)called;or, achangeintheprevailingmarketinterestrates. Ifabondtradesabovepar,itissaidtotradeatapremium.Ifabondtradesbelowpar,itissaidtotradeatadiscount.Forexample,ifthebondyoudesiretopurchasehasafixedinterestrateof8percent,andsimilar-qualitynewbondsavailableforsalehaveafixedinterestrateof5percent,youwilllikelypaymorethantheparamountofthebondthatyouintendtopurchase,becauseyouwillreceivemoreinterestincomethanthecurrentinterestrate(5percent)beingattachedtosimilarbonds.            SubscribetoUpdates