A bond is an agreement between an issuer (a large organisation such as a government, municipality, corporate, or sovereign body) and the holder, where the latter loans money to the issuer in exchange for periodic interest (coupon rate) and a final repayment of the principal after the bond’s maturity.
The loaned money or the holder’s principal is a one-time payment used to buy the bond from the issuer.
A bond is an example of a fixed-income investment instrument. Here are a few terms associated with the fixed-income market, relevant to bonds as well:-
- Issuer — Bonds can be issued by sovereign governments, quasi-government entities, corporates, and municipal bodies.
- Face value — It is the per unit price paid by the holder at the time the bond is first issued (in the primary market)
- Principal — It is the loan amount which the bond-holder initially pays to the issuer, against the issuer’s promise of promising of returning the principal at maturity.
- Maturity — Maturity the completion of the holding period of the bond, on which the principal becomes redeemable.
- Coupon rate — It is the interest rate which the issuer agrees to pay to the bondholder at specified intervals.
- Market price — The price of the bond unit in the secondary market. Bonds, after they are first issued, are often traded on the secondary market. That is when a market value, ie. the perceived value the market’s traders attach to it, come into effect.
- Yield to maturity (YTM) — It refers to the return which the investor will earn if the bond unit are held till maturity, assuming interest and the principal is paid on time.
It is the discount or internal interest rate which measures the future cash flows on the bond to its current market price on the secondary markets.
The bond’s secondary market value is determined by the ratings (of financial health and the ability to honour the repayment promise) of the issuer and the interest rates in the economy.