Due to the seeming complexity of the bond market and the terminology, many investors only make brief forays into bonds. Bonds are actually rather straightforward financial products. So, how do you enter this market segment? Learn these essential words for the bond market to get started investing in bonds.
Fundamental Bond Characteristics
Simply put, a bond is a loan that a business has obtained. The business obtains funding from investors who purchase its bonds rather than going to a bank. A bond’s annual interest rate, expressed as a percentage of face value, is paid by the company in exchange for capital in the form of an interest coupon. The lender repays the principal on the loan’s maturity date and collects the interest at predetermined intervals (typically annually or semiannually).
When choosing a bond, there are six crucial characteristics to keep an eye out for.
On this day, investors get their bond’s principal or par value, and the company’s bond obligation expires. As a result, it establishes the bond’s lifespan.
Either a bond is secured or unsecured. A secured bond guarantees certain assets to bondholders in the event that the issuer is unable to pay the debt. This item is also referred to as loan collateral.
Preference for Liquidation
When a company declares bankruptcy, it pays back investors in a specific order as it liquidates. A company starts paying out its investors once all of its assets have been sold. Junior (subordinated) debt must be paid after senior (or priority) debt. Any remaining assets are distributed to stockholders.
Interest is paid to bondholders in the form of a coupon, typically once a year or twice a year. The term “coupon” can also refer to the nominal yield or coupon rate. The coupon rate is determined by multiplying the annual payments by the bond’s face value.
Tax Status While most corporate bonds are taxable investments, some municipal and government bonds are tax-exempt, so profits and capital gains are not taxed.
Some bonds may be repaid by the issuer before they mature. If a bond has a call provision, it may be redeemed sooner than expected at the company’s discretion, typically for a small premium over par. If interest rates allow for better borrowing terms, a company may decide to call its bonds.