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8 Terminologies
You Must Know Before You Invest in Bonds
by GoldenPi April 22, 2019 15898 views

Bonds are considered to be complex because of some of the terminologies associated with this
investment. But actually, they’re just simple investments in the debt market (To know about
what are bonds and debentures, refer to this interesting article). A new bond investor may get
confused by some of the jargons associated with a bond investment. We bring you a brief list of
the most important bond jargon that you should understand and evaluate while making your
investment decision.

1. Coupon
A coupon payment is the amount of annual interest that will be paid to the bondholder on an
annual basis. The coupon payment per bond unit is:

Coupon Payment = Face Value of Bond X Coupon Rate of the Bond in %

This amount will be paid as per a pre-defined schedule – monthly, quarterly, bi-annually, or
annually until the date of maturity.

2. Face Value
Face value is the designated value per unit of a bond when the bond is issued by the bond issuer.
In the Indian bond market, the face value for most of the bonds is Rs.1000.

3. Market Value
The market value of a bond is the value at which the bond is currently being bought and sold in
the market. This happens after the bond has been issued at the face value. The market value of a
bond can be either at a premium or at a discount to the face value. The value depends on the
overall economic conditions, bond issuer industry state, and the bond issuer’s business condition.

4. Bond Issuer
The bond issuer is the bond issuing company or the borrower who sells bonds with the promise
of regular interest payments and return of the principal amount on maturity. The bondholder is
the lender who lends money to the bond issuer in exchange of a bond.

5. Payment Frequency
The payment frequency or payment schedule of bonds is the dates on which the interest is paid to
bondholders by bond issuing companies. The payment frequency can vary from monthly,
quarterly, bi-annually to annually. Some payment dates can be customized by the bondholder.

6. Maturity
The bond issuing company agrees to pay back the principal amount of the bond to the
bondholder on a pre-defined date. This is called the bond maturity date. Once the principal
amount is returned, the bondholder stops receiving the interest payments as well.

7. Yield to Maturity (YTM)

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Yield to maturity is the effective returns that an investor gets by investing in a bond and then
holding it till maturity. Simply put, the yield, measured in %, is the interest rate at which an
investor invests money in the bond to generate the cash flows from the bond till it matures.

Example:

Say, an investor invests Rs  950 (market value) in a bond. The various parameters of the bond
are:
Face Value per unit = Rs 1000 ; Coupon Rate = 10% ; Payment Schedule = 5 years on 30 th
April.

The payments that the investor will receive are :

Rs 100 on 31st April every year till the next five years. On maturity in the 5th year, the investor
gets back the face value = Rs 1000.

Then his effective returns or yield to maturity will be 11.352 % approximately.

The effective annual returns help in making a realistic comparison of different rates of returns of
bonds. For example, if a bond receives a quarterly payment of interest, then due to compounding
the effective annual returns will be higher than the actual interest returns.

8. Rating
A bond rating is a grade given to a bond depending on its creditworthiness. The ratings can vary
from AAA to AA to A and further down. AAA is considered the highest rating and bonds with
this rating are generally considered the safest.

Any bond that has credit ratings of BBB and above are labeled as investment-grade bonds or safe
bonds in India. This rating is given to the company (bond issuer) by rating agencies on the basis
of various financial factors of the bond issuer. Some of the most commonly considered factors
are the issuer’s previous financial strength or ability to repay the principal and interest on time.

Conclusion
While bonds are a very simple investment option, having a better understanding of the financial
terms associated with them will make you more confident about your investment decisions.
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