There are several important features that every bondholder must know before acquiring them:
• The bond properties – issuer, maturity, principal, coupon rate and frequency, and the currency in which they are denominated. These properties are determinants of the investor’s expected and actual returns.
• The tax and legal framework that applies to the contract between issuer and bondholder
• The contingency provisions that affect the bond’s scheduled cash flows.
In this article, we will focus on the bond properties and go through them one by one.
Many entities can issue bonds. Usually, bond issuers are classified into categories based on their characteristics:
1. International organizations: World Bank etc.
2. Sovereign governments: The Unites States of America, The United Kingdom, Japan, Germany, etc.
3. Local governments: states, regions, counties
4. Companies: corporate issuers
5. Specialized legal entities
Bondholders are exposed to credit risk, that is the risk of loss resulting from the issuer failing to pay the interest and/or repayment of principal. The issuer’s creditworthiness is rated by credit rating agencies.
The maturity date of a bond refers to the date on which the issuer is obligated to pay the outstanding principal amount. A bond’s term of maturity is the length of time in which the bondholder will receive the interest payments on the principal.
One notable exception is the perpetual bond, which is a fixed income security with no maturity date.
The principal amount of a bond is the amount the issuer agrees to pay the bondholder once the bond reaches maturity. The amount is also referred to as par value or nominal value. Bond prices are traded and quoted as a percentage of the principal amount. For example, if a bond’s par value is $100, a quote of 98 means that the price of the bond is worth $98. If the bond is trading below the par value it is said that it is trading at a discount. If the bond is traded above the par value it is said that it's trading at a premium.
Coupon rate and frequency
The coupon rate of a bond is the interest rate that the issuer agrees to pay each year to the bondholder until it reaches the maturity date. The annual sum paid is called the coupon. For example, a bond with a coupon rate of 3% and a par value of $10000 will pay an annual interest of $300.
A conventional bond pays a fixed income rate. However, there are bonds that pay a floating rate of interest; these bonds are called floating-rate notes. All bonds make periodic coupon payments except for zero-coupon bonds, which trade at a discount of their par value and pay zero annual interest.
Bonds can be issued in any currency although the largest number of bond issues are made in US dollars or euros. The currency of issue may affect the attractiveness of the bond, that’s why issuers from many countries in the world choose these 2 currencies to attract international investors and offset the disadvantages of their local currencies.
Trade with care.
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