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In
finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of Production (economics), production, Distribution (economics), distribution, and Consumption (economics) ...
, a bond is a type of
security Security is protection from, or resilience against, potential harm (or other unwanted Coercion, coercive change) caused by others, by restraining the freedom of others to act. Beneficiaries (technically referents) of security may be of persons an ...
under which the issuer (
debtor A debtor or debitor is a legal entity, legal entity (legal person) that owes a debt to another entity. The entity may be an individual, a firm, a government, a company or other legal person. The counterparty is called a creditor. When the counter ...
) owes the holder (
creditor A creditor or lender is a Party (law), party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided s ...
) a
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The de ...
, and is obliged – depending on the terms – to repay the principal (i.e. amount borrowed) of the bond at the maturity date as well as
interest In finance and economics, interest is payment from a debtor, borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is ...
(called the
coupon In marketing, a coupon is a ticket or document that can be redeemed for a financial discounts and allowances, discount or rebate (marketing), rebate when purchasing a product (business), product. Customarily, coupons are issued by manufacturers ...
) over a specified amount of time. The interest is usually payable at fixed intervals: semiannual, annual, and less often at other periods. Thus, a bond is a form of
loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that de ...
or IOU. Bonds provide the borrower with external funds to finance long-term investments or, in the case of
government bond A government bond or sovereign bond is a form of bond issued by a government A government is the system or group of people governing an organized community, generally a state. In the case of its broad associative definition, go ...
s, to finance current expenditure. Bonds and
stock In finance, stock (also capital stock) consists of all the Share (finance), shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which owners ...
s are both
securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
, but the major difference between the two is that (capital)
stockholder A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a Trust law, trust or partnership) that is registered by the corporation as the ...
s have an equity stake in a company (i.e. they are owners), whereas bondholders have a creditor stake in a company (i.e. they are lenders). As creditors, bondholders have priority over stockholders. This means they will be repaid in advance of stockholders, but will rank behind
secured creditor A secured creditor is a creditor A creditor or lender is a Party (law), party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first ...
s, in the event of bankruptcy. Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks typically remain outstanding indefinitely. An exception is an irredeemable bond, which is a
perpetuity A perpetuity is an annuity that has no end, or a stream of cash payments that continues forever. There are few actual perpetuities in existence. For example, the United Kingdom The United Kingdom of Great Britain and Northern Ireland, ...
, that is, a bond with no maturity. Certificates of deposit (CDs) or short-term commercial paper are classified as
money market The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less. As Security (finance)#Debt, short-term securities became a commodity, the mone ...
instruments and not bonds: the main difference is the length of the term of the instrument. The most common forms include
municipal A municipality is usually a single administrative division Administrative division, administrative unit,Article 3(1). country subdivision, administrative region, subnational entity, constituent state, as well as many similar terms, are ge ...
,
corporate A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal ...
, and
government bonds A government bond or sovereign bond is a form of Bond (finance), bond issued by a government to support government spending, public spending. It generally includes a commitment to pay periodic interest, called Coupon (finance), coupon payments' ...
. Very often the bond is negotiable, that is, the ownership of the instrument can be transferred in the
secondary market The secondary market, also called the aftermarket and follow on public offering, is the financial markets, financial market in which previously issued financial instruments such as stock, Bond (finance), bonds, option (finance), options, and Fut ...
. This means that once the transfer agents at the bank medallion-stamp the bond, it is highly
liquid A liquid is a nearly Compressibility, incompressible fluid that conforms to the shape of its container but retains a (nearly) constant volume independent of pressure. As such, it is one of State of matter#Four fundamental states, the four fund ...
on the secondary market. The price of a bond in the secondary market may differ substantially from the principal due to various factors in bond valuation.


Etymology

In English, the word "" relates to the etymology of "bind". The use of the word "bond" in this sense of an "instrument binding one to pay a sum to another" dates from at least the 1590s.


Issuance

Bonds are issued by public authorities, credit institutions, companies and supranational institutions in the
primary market :''"Primary market" may also refer to Art valuation#Primary and secondary markets, a market in art valuation.'' The primary market is the part of the capital market that deals with the issuance and sale of securities to purchasers directly by the i ...
s. The most common process for issuing bonds is through
underwriting Underwriting (UW) services are provided by some large financial institutions, such as banks, insurance companies and investment houses, whereby they guarantee payment in case of damage or financial loss and accept the financial risk for liabil ...
. When a bond issue is underwritten, one or more securities firms or banks, forming a
syndicate A syndicate is a self-organizing group of individuals, companies, corporations or entities formed to transact some specific business, to pursue or promote a shared interest. Etymology The word ''syndicate'' comes from the French language, Frenc ...
, buy the entire issue of bonds from the issuer and resell them to investors. The security firm takes the risk of being unable to sell on the issue to end investors. Primary issuance is arranged by '' bookrunners'' who arrange the bond issue, have direct contact with investors and act as advisers to the bond issuer in terms of timing and price of the bond issue. The bookrunner is listed first among all underwriters participating in the issuance in the tombstone ads commonly used to announce bonds to the public. The bookrunners' willingness to underwrite must be discussed prior to any decision on the terms of the bond issue as there may be limited demand for the bonds. In contrast, government bonds are usually issued in an auction. In some cases, both members of the public and banks may bid for bonds. In other cases, only market makers may bid for bonds. The overall rate of return on the bond depends on both the terms of the bond and the price paid. The terms of the bond, such as the coupon, are fixed in advance and the price is determined by the market. In the case of an underwritten bond, the underwriters will charge a fee for underwriting. An alternative process for bond issuance, which is commonly used for smaller issues and avoids this cost, is the private placement bond. Bonds sold directly to buyers may not be tradeable in the
bond market The bond market (also debt market or credit market) is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt security (finance), securities, known as the secondary market. This is usually in th ...
. Historically, an alternative practice of issuance was for the borrowing government authority to issue bonds over a period of time, usually at a fixed price, with volumes sold on a particular day dependent on market conditions. This was called a ''tap issue'' or ''bond tap''.


Features


Principal

Nominal, principal, par, or face amount is the amount on which the issuer pays interest, and which, most commonly, has to be repaid at the end of the term. Some structured bonds can have a redemption amount which is different from the face amount and can be linked to the performance of particular assets.


Maturity

The issuer is obligated to repay the nominal amount on the maturity date. As long as all due payments have been made, the issuer has no further obligations to the bond holders after the maturity date. The length of time until the maturity date is often referred to as the term or tenor or maturity of a bond. The maturity can be any length of time, although debt securities with a term of less than one year are generally designated money market instruments rather than bonds. Most bonds have a term shorter than 30 years. Some bonds have been issued with terms of 50 years or more, and historically there have been some issues with no maturity date (irredeemable). In the market for United States Treasury securities, there are four categories of bond maturities: * short term (bills): maturities between zero and one year; * medium term (notes): maturities between one and ten years; * long term (bonds): maturities between ten and thirty years; * Perpetual: no maturity Period.


Coupon

The
coupon In marketing, a coupon is a ticket or document that can be redeemed for a financial discounts and allowances, discount or rebate (marketing), rebate when purchasing a product (business), product. Customarily, coupons are issued by manufacturers ...
is the interest rate that the issuer pays to the holder. For fixed rate bonds, the coupon is fixed throughout the life of the bond. For floating rate notes, the coupon varies throughout the life of the bond and is based on the movement of a
money market The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less. As Security (finance)#Debt, short-term securities became a commodity, the mone ...
reference rate (often LIBOR). Historically, coupons were physical attachments to the paper bond certificates, with each coupon representing an interest payment. On the interest due date, the bondholder would hand in the coupon to a bank in exchange for the interest payment. Today, interest payments are almost always paid electronically. Interest can be paid at different frequencies: generally semi-annual (every 6 months) or annual.


Yield

The yield is the rate of return received from investing in the bond. It usually refers to one of the following: * The current yield, or running yield: the annual interest payment divided by the current market price of the bond (often the clean price). * The
yield to maturity The yield to maturity (YTM), book yield or redemption yield of a Bond (finance), bond or other security (finance), fixed-interest security, such as Gilt-edged securities, gilts, is an estimate of the total rate of return anticipated to be earned ...
(or redemption yield, as it is termed in the United Kingdom) is an estimate of the total rate of return anticipated to be earned by an investor who buys a bond at a given market price, holds it to maturity, and receives all interest payments and the capital redemption on schedule. It is a more useful measure of the return on a bond than current yield because it takes into account the
present value In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has inte ...
of future interest payments and principal repaid at maturity. The yield to maturity or redemption yield calculated at the time of purchase is not necessarily the return the investor will actually earn, as finance scholars Dr. Annette Thau and Dr. Frank Fabozzi have noted. The yield to maturity will be realized only under certain conditions, including: 1) all interest payments are reinvested rather than spent, and 2) all interest payments are reinvested at the yield to maturity calculated at the time the bond is purchased. This distinction may not be a concern to bond buyers who intend to spend rather than reinvest the coupon payments, such as those practicing asset/liability matching strategies.


Credit quality

The quality of the issue refers to the probability that the bondholders will receive the amounts promised at the due dates. In other words, credit quality tells investors how likely the borrower is going to default. This will depend on a wide range of factors.
High-yield bond In finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of Production (economics), production, Distribution (economics), distribution, and Consump ...
s are bonds that are rated below investment grade by the credit rating agencies. As these bonds are riskier than investment grade bonds, investors expect to earn a higher yield. These bonds are also called ''junk bonds''.


Market price

The market price of a tradable bond will be influenced, among other factors, by the amounts, currency and timing of the interest payments and capital repayment due, the quality of the bond, and the available redemption yield of other comparable bonds which can be traded in the markets. The price can be quoted as clean or dirty. "Dirty" includes the present value of all future cash flows, including accrued interest, and is most often used in Europe. "Clean" does not include accrued interest, and is most often used in the U.S. The issue price at which investors buy the bonds when they are first issued will typically be approximately equal to the nominal amount. The net proceeds that the issuer receives are thus the issue price, less issuance fees. The market price of the bond will vary over its life: it may trade at a premium (above par, usually because market interest rates have fallen since issue), or at a discount (price below par, if market rates have risen or there is a high probability of default on the bond).


Others

* Indentures and Covenants—An
indenture An indenture is a legal contract that reflects or covers a debt or purchase obligation. It specifically refers to two types of practices: in historical usage, an indentured servant status, and in modern usage, it is an instrument used for commercia ...
is a formal debt agreement that establishes the terms of a bond issue, while covenants are the clauses of such an agreement. Covenants specify the rights of bondholders and the duties of issuers, such as actions that the issuer is obligated to perform or is prohibited from performing. In the U.S., federal and state securities and commercial laws apply to the enforcement of these agreements, which are construed by courts as contracts between issuers and bondholders. The terms may be changed only with great difficulty while the bonds are outstanding, with amendments to the governing document generally requiring approval by a
majority A majority, also called a simple majority or absolute majority to distinguish it from #Related terms, related terms, is more than half of the total.Dictionary definitions of ''majority'' aMerriam-Webstersuper-majority A supermajority, supra-majority, qualified majority, or special majority is a requirement for a proposal to gain a specified level of support which is greater than the threshold of more than one-half used for a simple majority. Supermajority ru ...
) vote of the bondholders. * Optionality: Occasionally a bond may contain an embedded option; that is, it grants option-like features to the holder or the issuer: ** Callability—Some bonds give the issuer the right to repay the bond before the maturity date on the call dates; see
call option In finance, a call option, often simply labeled a "call", is a contract between the buyer and the seller of the call Option (finance), option to exchange a Security (finance), security at a set price. The buyer of the call option has the righ ...
. These bonds are referred to as callable bonds. Most callable bonds allow the issuer to repay the bond at par. With some bonds, the issuer has to pay a premium, the so-called call premium. This is mainly the case for high-yield bonds. These have very strict covenants, restricting the issuer in its operations. To be free from these covenants, the issuer can repay the bonds early, but only at a high cost. ** Puttability—Some bonds give the holder the right to force the issuer to repay the bond before the maturity date on the put dates; see put option. These are referred to as retractable or putable bonds. ** Call dates and put dates—the
dates Date or dates may refer to: *Date (fruit), the fruit of the date palm (''Phoenix dactylifera'') Social activity *Dating, a form of courtship involving social activity, with the aim of assessing a potential partner **Group dating *Play date, an ...
on which callable and putable bonds can be redeemed early. There are four main categories: *** A Bermudan callable has several call dates, usually coinciding with coupon dates. *** A European callable has only one call date. This is a special case of a Bermudan callable. *** An American callable can be called at any time until the maturity date. *** A death put is an optional redemption feature on a debt instrument allowing the beneficiary of the estate of a deceased bondholder to put (sell) the bond back to the issuer at face value in the event of the bondholder's death or legal incapacitation. This is also known as a "survivor's option". **
Sinking fund A sinking fund is a fund established by an economic entity by setting aside revenue over a period of time to fund a future capital expense, or repayment of a long-term debt. In North America and elsewhere where it is common for public and privat ...
provision of the corporate bond indenture requires a certain portion of the issue to be retired periodically. The entire bond issue can be liquidated by the maturity date; if not, the remainder is called balloon maturity. Issuers may either pay to trustees, which in turn call randomly selected bonds in the issue, or, alternatively, purchase bonds in the open market, then return them to trustees. *** Bonds are often identified by their international securities identification number, or
ISIN Isin (, modern Arabic language, Arabic: Ishan al-Bahriyat) is an archaeological site in Al-Qādisiyyah Governorate, Iraq. Excavations have shown that it was an important city-state in the past. History of archaeological research Ishan al-Bahri ...
, which is a 12-digit alphanumeric code that uniquely identifies debt securities.


Types

Bonds can be categorised in several ways, such as the type of issuer, the currency, the term of the bond (length of time to maturity) and the conditions applying to the bond. The following descriptions are not mutually exclusive, and more than one of them may apply to a particular bond:


The nature of the issuer and the security offered

The nature of the issuer will affect the security (certainty of receiving the contracted payments) offered by the bond, and sometimes the tax treatment. *
Government bond A government bond or sovereign bond is a form of bond issued by a government A government is the system or group of people governing an organized community, generally a state. In the case of its broad associative definition, go ...
s, often also called Treasury bonds, are issued by a national government. Some countries have repeatedly defaulted on their government bonds. However the bonds issued by some national governments are sometimes treated as risk-free and not exposed to default risk. Risk-free bonds are thus the safest bonds, with the lowest interest rate. A Treasury bond is backed by the "full faith and credit" of the relevant government. However in reality most or all government bonds do carry some residual risk. This is indicated by **the award by
rating agencies A credit rating agency (CRA, also called a ratings service) is a company that assigns credit ratings, which rate a debtor's ability to pay back debt by making timely principal and interest payments and the likelihood of Default (finance), default ...
of a rating below the top rating, **bonds issued by different national governments, such as various member states of the European Union, all denominated in Euros, offering different market yields reflecting their different risks. * A supranational bond, also known as a "supra", is issued by a supranational organisation like the
World Bank The World Bank is an international financial institution that provides loans and Grant (money), grants to the governments of Least developed countries, low- and Developing country, middle-income countries for the purpose of pursuing capital pro ...
. They have a very good credit rating, similar to that on national government bonds. * A
municipal bond A municipal bond, commonly known as a muni, is a bond issued by state or local governments, or entities they create such as authorities and special districts. In the United States, interest income received by holders of municipal bonds is often, ...
issued by a local authority or subdivision within a country, for example a city or a federal state. These will to varying degrees carry the backing of the national government. In the United States, such bonds are exempt from certain taxes. For example, Build America Bonds (BABs) are a form of municipal bond authorized by the
American Recovery and Reinvestment Act of 2009 The American Recovery and Reinvestment Act of 2009 (ARRA) (), nicknamed the Recovery Act, was a Stimulus (economics), stimulus package enacted by the 111th U.S. Congress and signed into law by President Barack Obama in February 2009. Developed i ...
. Unlike traditional US municipal bonds, which are usually tax exempt, interest received on BABs is subject to federal taxation. However, as with municipal bonds, the bond is tax-exempt within the US state where it is issued. Generally, BABs offer significantly higher yields than standard municipal bonds. ** A revenue bond is a special type of municipal bond distinguished by its guarantee of repayment solely from revenues generated by a specified revenue-generating entity associated with the purpose of the bonds. Revenue bonds are typically "non-recourse", meaning that in the event of default, the bond holder has no recourse to other governmental assets or revenues. * A
War bond War bonds (sometimes referred to as Victory bonds, particularly in propaganda) are Security (finance)#Debt, debt securities issued by a government to finance military operations and other expenditure in times of war without raising taxes to an un ...
is a bond issued by a government to fund military operations and other expenditure during wartime. Investment in such bonds may be motivated by a lack of other investment or spending opportunities, and/or by an appeal to patriotism. Thus such bonds often have a low return rate. *
High-yield bond In finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of Production (economics), production, Distribution (economics), distribution, and Consump ...
s (junk bonds) are bonds that are rated below investment grade by the credit rating agencies, because they are uncertain that the issuer will be able or willing to pay the scheduled interest payments and/or redeem the bond at maturity. As these bonds are much riskier than investment grade bonds, investors expect to earn a much higher yield. * A
Climate bond Green bonds (also known as climate bonds) are fixed-income financial instruments (Bond (finance), bonds) which are used to fund projects that have positive environmental and/or Climate change mitigation, climate benefits. They follow the Green B ...
is a bond issued by a government or corporate entity in order to raise finance for climate change mitigation- or adaptation-related projects or programmes. For example, in 2021 the UK government started to issue "green bonds". * Covered bonds are backed by cash flows from mortgages or public sector assets. Unlike asset-backed securities, the assets for such bonds remain on the issuer's balance sheet. * Asset-backed securities are bonds whose interest and principal payments are backed by underlying cash flows from other assets. Examples of asset-backed securities are mortgage-backed securities (MBSs),
collateralized mortgage obligation A collateralized mortgage obligation (CMO) is a type of complex debt security that repackages and directs the payments of principal and interest from a collateral pool to different types and maturities of securities, thereby meeting investor need ...
s (CMOs), and
collateralized debt obligation A collateralized debt obligation (CDO) is a type of structured finance, structured asset-backed security (ABS). Originally developed as instruments for the corporate debt markets, after 2002 CDOs became vehicles for refinancing Mortgage-backed se ...
s (CDOs). * Subordinated bonds are those that have a lower priority than other bonds of the issuer in case of
liquidation Liquidation is the process in accounting by which a company (law), company is brought to an end in Canada, United Kingdom, United States, Republic of Ireland, Ireland, Australia, New Zealand, Italy, and many other countries. The assets and p ...
. In case of bankruptcy, there is a hierarchy of creditors. First the liquidator is paid, then government taxes, etc. The first bond holders in line to be paid are those holding what are called senior bonds. After they have been paid, the subordinated bond holders are paid. As a result, the risk is higher. Therefore, subordinated bonds usually have a lower credit rating than senior bonds. The main examples of subordinated bonds can be found in bonds issued by banks and asset-backed securities. The latter are often issued in
tranche In structured finance, a tranche is one of a number of related Security (finance), securities offered as part of the same transaction. In the financial sense of the word, each Bond (finance), bond is a different slice of the deal's risk. Transac ...
s. The senior tranches get paid back first, the subordinated tranches later. * Social impact bonds are an agreement for public sector entities to pay back private investors after meeting verified improved social outcome goals that result in public sector savings from innovative social program pilot projects.


The term of the bond

* Most bonds are structured to mature on a stated date, when the principal is due to be repaid, and interest payments cease. Typically, a bond with term to maturity of under five years would be called a short bond; 5 to 15 years would be "medium", and over 15 years would be "long"; but the numbers may vary in different markets. *
Perpetual bond A perpetual bond, also known colloquially as a perpetual or perp, is a Bond (finance), bond with no maturity date, therefore allowing it to be treated as Equity (finance), equity, not as debt. Issuers pay Coupon (bond), coupons on perpetual bonds ...
s are also often called perpetuities or 'Perps'. They have no maturity date. Historically the most famous of these were the UK Consols (there were also some other perpetual UK government bonds, such as War Loan, Treasury Annuities and undated Treasuries). Some of these were issued back in 1888 or earlier. There had been insignificant quantities of these outstanding for decades, and they have now been fully repaid. Some ultra-long-term bonds (sometimes a bond can last centuries: West Shore Railroad issued a bond which matures in 2361 (i.e. 24th century)) are virtually perpetuities from a financial point of view, with the current value of principal near zero. * The ''Methuselah'' is a type of bond with a maturity of 50 years or longer. The term is a reference to
Methuselah Methuselah () ( he, מְתוּשֶׁלַח ''Məṯūšélaḥ'', in pausa ''Məṯūšālaḥ'', "His death shall send" or "Man of the javelin" or "Death of Sword"; gr, Μαθουσάλας ''Mathousalas'') was a Patriarchs (Bible), biblic ...
, the oldest person whose age is mentioned in the
Hebrew Bible The Hebrew Bible or Tanakh (;"Tanach"
''Random House Webster's Unabridged Dictionary''.
Hebrew: ''Tān ...
. The issuance of Methuselahs has been increasing in recent years due to demand for longer-dated assets from
pension A pension (, from Latin ''pensiō'', "payment") is a fund into which a sum of money is added during an employee's employment years and from which payments are drawn to support the person's retirement from work in the form of periodic payments ...
plans, particularly in
France France (), officially the French Republic ( ), is a country primarily located in Western Europe. It also comprises of Overseas France, overseas regions and territories in the Americas and the Atlantic Ocean, Atlantic, Pacific Ocean, Pac ...
and the
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the European mainland, continental mainland. It comprises England, Scotlan ...
. Issuance of Methuselahs in the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...
has been limited, however: the U.S. Treasury does not currently issue Treasuries with maturities beyond 30 years, which would serve as a reference level for any
corporate A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal ...
issuance. * Serial bond is a bond that matures in installments over a period of time. In effect, a $100,000, 5-year serial bond would mature in a $20,000 annuity over a 5-year interval.


The conditions applying to the bond

* Fixed rate bonds have interest payments ("coupon"), usually semi-annual, that remains constant throughout the life of the bond. Other variations include stepped-coupon bonds, whose coupon increases during the life of the bond. * Floating rate notes (FRNs, floaters) have a variable coupon that is linked to a reference rate of interest, such as Libor or
Euribor The Euro Interbank Offered Rate (Euribor) is a daily reference rate, published by the European Money Markets Institute, based on the averaged interest rates at which Eurozone banks offer to lend unsecured loan, unsecured funding, funds to other ...
. For example, the coupon may be defined as three-month USD LIBOR + 0.20%. The coupon rate is recalculated periodically, typically every one or three months. * Zero-coupon bonds (zeros) pay no regular interest. They are issued at a substantial discount to
par value Par value, in finance and accounting, means stated value or face value. From this come the expressions at par (at the par value), over par (over par value) and under par (under par value). Bonds A Bond_(finance), bond selling at par is priced at 1 ...
, so that the interest is effectively rolled up to maturity (and usually taxed as such). The bondholder receives the full principal amount on the redemption date. An example of zero coupon bonds is Series E savings bonds issued by the U.S. government. Zero-coupon bonds may be created from fixed rate bonds by a financial institution separating ("stripping off") the coupons from the principal. In other words, the separated coupons and the final principal payment of the bond may be traded separately. See IO (Interest Only) and PO (Principal Only). *
Inflation-indexed bond Daily inflation-indexed bonds (also known as inflation-linked bonds or colloquially as linkers) are Bond (finance), bonds where the principal is indexed to inflation or deflation on a daily basis. They are thus designed to hedge the inflation ris ...
s (linkers) (US) or index-linked bonds (UK), in which the principal amount and the interest payments are indexed to inflation. The interest rate is normally lower than for fixed rate bonds with a comparable maturity (this position briefly reversed itself for short-term UK bonds in December 2008). However, as the principal amount grows, the payments increase with inflation. The
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the European mainland, continental mainland. It comprises England, Scotlan ...
was the first sovereign issuer to issue inflation linked gilts in the 1980s.
Treasury Inflation-Protected Securities United States Treasury securities, also called Treasuries or Treasurys, are government bond, government debt instruments issued by the United States Department of the Treasury to finance government spending as an alternative to taxation. Sin ...
(TIPS) and I-bonds are examples of inflation-linked bonds issued by the U.S. government. * Other indexed bonds, for example equity-linked notes and bonds indexed on a business indicator (income, added value) or on a country's
GDP Gross domestic product (GDP) is a money, monetary Measurement in economics, measure of the market value of all the final goods and services produced and sold (not resold) in a specific time period by countries. Due to its complex and subjec ...
. * Lottery bonds are issued by European and other states. Interest is paid as on a traditional fixed rate bond, but the issuer will redeem randomly selected individual bonds within the issue according to a schedule. Some of these redemptions will be for a higher value than the face value of the bond.


Bonds with embedded options for the holder

*
Convertible bond In finance, a convertible bond or convertible note or convertible debt (or a convertible debenture if it has a maturity of greater than 10 years) is a type of bond (finance), bond that the holder can convert into a specified number of shares of ...
s let a bondholder exchange a bond to a number of shares of the issuer's common stock. These are known as hybrid securities, because they combine equity and
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The de ...
features. * Exchangeable bonds allows for exchange to shares of a corporation other than the issuer.


Documentation and evidence of title

* A
bearer bond A bearer bond is a bond (finance), bond or debt security issued by a business entity such as a corporation or a government. As a bearer instrument, it differs from the more common types of investment securities in that it is unregistered—no re ...
is an official certificate issued without a named holder. In other words, the person who has the paper certificate can claim the value of the bond. Often they are registered by a number to prevent counterfeiting, but may be traded like cash. Bearer bonds are very risky because they can be lost or stolen. In some countries they were historically popular because the owner could not be traced by the tax authorities. For example, after federal income tax began in the United States, bearer bonds were seen as an opportunity to conceal income or assets. U.S. corporations stopped issuing bearer bonds in the 1960s, the U.S. Treasury stopped in 1982, and state and local tax-exempt bearer bonds were prohibited in 1983. * A registered bond is a bond whose ownership (and any subsequent purchaser) is recorded by the issuer, or by a transfer agent. It is the opposite of a
bearer bond A bearer bond is a bond (finance), bond or debt security issued by a business entity such as a corporation or a government. As a bearer instrument, it differs from the more common types of investment securities in that it is unregistered—no re ...
. Interest payments, and the principal upon maturity are sent to the registered owner. * A book-entry bond is a bond that does not have a paper certificate. As physically processing paper bonds and interest coupons became more expensive, issuers (and banks that used to collect coupon interest for depositors) have tried to discourage their use. Some book-entry bond issues do not offer the option of a paper certificate, even to investors who prefer them.


Retail bonds

* Retail bonds are a type of corporate bond mostly designed for ordinary investors.


Foreign currencies

Some companies, banks, governments, and other sovereign entities may decide to issue bonds in foreign currencies as the foreign currency may appear to potential investors to be more stable and predictable than their domestic currency. Issuing bonds denominated in foreign currencies also gives issuers the ability to access investment capital available in foreign markets. A downside is that the government loses the option to reduce its bond liabilities by inflating its domestic currency. The proceeds from the issuance of these bonds can be used by companies to break into foreign markets, or can be converted into the issuing company's local currency to be used on existing operations through the use of foreign exchange swap hedges. Foreign issuer bonds can also be used to hedge foreign exchange rate risk. Some foreign issuer bonds are called by their nicknames, such as the "samurai bond". These can be issued by foreign issuers looking to diversify their investor base away from domestic markets. These bond issues are generally governed by the law of the market of issuance, e.g., a samurai bond, issued by an investor based in Europe, will be governed by Japanese law. Not all of the following bonds are restricted for purchase by investors in the market of issuance.


Bond valuation

The market price of a bond is the
present value In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has inte ...
of all expected
future interest In property law and real estate, a future interest is a legal right to property ownership that does not include the right to present possession or enjoyment of the property. Future interests are created on the formation of a defeasible estate; t ...
and principal payments of the bond, here discounted at the bond's
yield to maturity The yield to maturity (YTM), book yield or redemption yield of a Bond (finance), bond or other security (finance), fixed-interest security, such as Gilt-edged securities, gilts, is an estimate of the total rate of return anticipated to be earned ...
(i.e.
rate of return In finance, return is a Profit (accounting), profit on an investment. It comprises any change in value of the investment, and/or cash flows (or securities, or other investments) which the investor receives from that investment, such as interest pa ...
). That relationship is the definition of the redemption yield on the bond, which is likely to be close to the current market interest rate for other bonds with similar characteristics, as otherwise there would be
arbitrage In economics and finance, arbitrage (, ) is the practice of taking advantage of a difference in prices in two or more Market (economics), markets; striking a combination of matching deals to capitalise on the difference, the profit being the di ...
opportunities. The yield and price of a bond are inversely related so that when market interest rates rise, bond prices fall and vice versa. For a discussion of the mathematics see Bond valuation. The bond's market price is usually expressed as a percentage of nominal value: 100% of face value, "at par", corresponds to a price of 100; prices can be above par (bond is priced at greater than 100), which is called trading at a premium, or below par (bond is priced at less than 100), which is called trading at a discount. The
market price A price is the (usually not negative) quantity of payment or Financial compensation, compensation given by one Party (law), party to another in return for Good (economics), goods or Service (economics), services. In some situations, the pr ...
of a bond may be quoted including the accrued interest since the last coupon date. (Some bond markets include accrued interest in the trading price and others add it on separately when settlement is made.) The price including accrued interest is known as the "full" or " dirty price". (''See also'' Accrual bond.) The price excluding accrued interest is known as the "flat" or " clean price". Most government bonds are denominated in units of $1000 in the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...
, or in units of £100 in the
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the European mainland, continental mainland. It comprises England, Scotlan ...
. Hence, a deep discount US bond, selling at a price of 75.26, indicates a selling price of $752.60 per bond sold. (Often, in the US, bond prices are quoted in points and thirty-seconds of a point, rather than in decimal form.) Some short-term bonds, such as the U.S. Treasury bill, are always issued at a discount, and pay par amount at maturity rather than paying coupons. This is called a discount bond. Although bonds are not necessarily issued at par (100% of face value, corresponding to a price of 100), their prices will move towards par as they approach maturity (if the market expects the maturity payment to be made in full and on time) as this is the price the issuer will pay to redeem the bond. This is referred to as " pull to par". At the time of issue of the bond, the coupon paid, and other conditions of the bond, will have been influenced by a variety of factors, such as current market interest rates, the length of the term and the creditworthiness of the issuer. These factors are likely to change over time, so the market price of a bond will vary after it is issued. (The position is a bit more complicated for inflation-linked bonds.) The interest payment ("coupon payment") divided by the current price of the bond is called the current yield (this is the nominal yield multiplied by the par value and divided by the price). There are other yield measures that exist such as the yield to first call, yield to worst, yield to first par call, yield to put, cash flow yield and yield to maturity. The relationship between yield and term to maturity (or alternatively between yield and the weighted mean term allowing for both interest and capital repayment) for otherwise identical bonds derives the
yield curve In finance, the yield curve is a graph which depicts how the Yield to maturity, yields on debt instruments - such as bonds - vary as a function of their years remaining to Maturity (finance), maturity. Typically, the graph's horizontal or ...
, a graph plotting this relationship. If the bond includes embedded options, the valuation is more difficult and combines option pricing with discounting. Depending on the type of option, the option price as calculated is either added to or subtracted from the price of the "straight" portion. See further under . This total is then the value of the bond. More sophisticated lattice- or simulation-based techniques may (also) be employed. Bond markets, unlike stock or share markets, sometimes do not have a centralized exchange or trading system. Rather, in most developed
bond market The bond market (also debt market or credit market) is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt security (finance), securities, known as the secondary market. This is usually in th ...
s such as the U.S., Japan and western Europe, bonds trade in decentralized, dealer-based
over-the-counter Over-the-counter (OTC) drugs are medicines sold directly to a consumer without a requirement for a prescription from a healthcare professional, as opposed to prescription drugs, which may be supplied only to consumers possessing a valid pres ...
markets. In such a market, liquidity is provided by dealers and other market participants committing risk capital to trading activity. In the bond market, when an investor buys or sells a bond, the
counterparty A counterparty (sometimes contraparty) is a Juristic person, legal entity, unincorporated entity, or collection of entities to which an exposure of financial risk may exist. The word became widely used in the 1980s, particularly at the time of the ...
to the trade is almost always a bank or securities firm acting as a dealer. In some cases, when a dealer buys a bond from an investor, the dealer carries the bond "in inventory", i.e. holds it for their own account. The dealer is then subject to risks of price fluctuation. In other cases, the dealer immediately resells the bond to another investor. Bond markets can also differ from stock markets in that, in some markets, investors sometimes do not pay brokerage commissions to dealers with whom they buy or sell bonds. Rather, the dealers earn revenue by means of the spread, or difference, between the price at which the dealer buys a bond from one investor—the "bid" price—and the price at which he or she sells the same bond to another investor—the "ask" or "offer" price. The bid/offer spread represents the total
transaction cost In economics Economics () is the social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the behavi ...
associated with transferring a bond from one investor to another.


Investing in bonds

Bonds are bought and traded mostly by institutions like
central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial bank, commercial banking system. In contrast to a commercial ba ...
s,
sovereign wealth fund A sovereign wealth fund (SWF), sovereign investment fund, or social wealth fund is a state-owned investment fund that invests in real and financial assets such as stocks, Bond (finance), bonds, real estate, precious metals, or in alternative inve ...
s,
pension fund A pension fund, also known as a superannuation fund in some countries, is any plan, fund, or scheme which provides pension, retirement income. Pension funds typically have large amounts of money to invest and are the major investors in listed a ...
s,
insurance companies Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management Risk management is th ...
,
hedge fund A hedge fund is a pooled investment fund that trades in relatively Market liquidity, liquid assets and is able to make extensive use of more complex trader (finance), trading, portfolio (finance), portfolio-construction, and risk management techn ...
s, and
bank A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets. Beca ...
s. Insurance companies and pension funds have liabilities which essentially include fixed amounts payable on predetermined dates. They buy the bonds to match their liabilities, and may be compelled by law to do this. Most individuals who want to own bonds do so through bond funds. Still, in the U.S., nearly 10% of all bonds outstanding are held directly by households. The volatility of bonds (especially short and medium dated bonds) is lower than that of equities (stocks). Thus, bonds are generally viewed as safer investments than
stock In finance, stock (also capital stock) consists of all the Share (finance), shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which owners ...
s, but this perception is only partially correct. Bonds do suffer from less day-to-day volatility than stocks, and bonds' interest payments are sometimes higher than the general level of
dividend A dividend is a distribution of Profit (accounting), profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed ...
payments. Bonds are often liquid – it is often fairly easy for an institution to sell a large quantity of bonds without affecting the price much, which may be more difficult for equities – and the comparative certainty of a fixed interest payment twice a year and a fixed lump sum at maturity is attractive. Bondholders also enjoy a measure of legal protection: under the law of most countries, if a company goes
bankrupt Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debtor ...
, its bondholders will often receive some money back (the recovery amount), whereas the company's equity stock often ends up valueless. However, bonds can also be risky but less risky than stocks: * Fixed rate bonds are subject to '' interest rate risk'', meaning that their market prices will decrease in value when the generally prevailing interest rates rise. Since the payments are fixed, a decrease in the market price of the bond means an increase in its yield. When the market interest rate rises, the
market price A price is the (usually not negative) quantity of payment or Financial compensation, compensation given by one Party (law), party to another in return for Good (economics), goods or Service (economics), services. In some situations, the pr ...
of bonds will fall, reflecting investors' ability to get a higher interest rate on their money elsewhere—perhaps by purchasing a newly issued bond that already features the newly higher interest rate. This does not affect the interest payments to the bondholder, so long-term investors who want a specific amount at the maturity date do not need to worry about price swings in their bonds and do not suffer from interest rate risk. Bonds are also subject to various other risks such as call and prepayment risk,
credit risk A credit risk is risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased ...
, reinvestment risk, liquidity risk, event risk, exchange rate risk, volatility risk, inflation risk, sovereign risk and yield curve risk. Again, some of these will only affect certain classes of investors. Price changes in a bond will immediately affect
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase Security (finance), securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe ...
s that hold these bonds. If the value of the bonds in their trading
portfolio Portfolio may refer to: Objects * Portfolio (briefcase), a type of briefcase Collections * Portfolio (finance), a collection of assets held by an institution or a private individual * Artist's portfolio, a sample of an artist's work or a c ...
falls, the value of the portfolio also falls. This can be damaging for professional investors such as banks, insurance companies, pension funds and asset managers (irrespective of whether the value is immediately " marked to market" or not). If there is any chance a holder of individual bonds may need to sell their bonds and "cash out", interest rate risk could become a real problem, conversely, bonds' market prices would increase if the prevailing interest rate were to drop, as it did from 2001 through 2003. One way to quantify the interest rate risk on a bond is in terms of its duration. Efforts to control this risk are called
immunization Immunization, or immunisation, is the process by which an individual's immune system becomes fortified against an infectious agent (known as the antigen, immunogen). When this system is exposed to molecules that are foreign to the body, called ...
or hedging. * Bond prices can become volatile depending on the credit rating of the issuer – for instance if the credit rating agencies like
Standard & Poor's S&P Global Ratings (previously Standard & Poor's and informally known as S&P) is an American credit rating agency (CRA) and a division of S&P Global that publishes financial research and analysis on capital stock, stocks, Bond (finance), bonds, ...
and
Moody's Moody's Investors Service, often referred to as Moody's, is the bond credit rating business of Moody's Corporation, representing the company's traditional line of business and its historical name. Moody's Investors Service provides international ...
upgrade or downgrade the credit rating of the issuer. An unanticipated downgrade will cause the market price of the bond to fall. As with interest rate risk, this risk does not affect the bond's interest payments (provided the issuer does not actually default), but puts at risk the market price, which affects mutual funds holding these bonds, and holders of individual bonds who may have to sell them. * A company's bondholders may lose much or all their money if the company goes
bankrupt Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debtor ...
. Under the laws of many countries (including the United States and Canada), bondholders are in line to receive the proceeds of the sale of the assets of a liquidated company ahead of some other creditors. Bank lenders, deposit holders (in the case of a deposit taking institution such as a bank) and trade creditors may take precedence. There is no guarantee of how much money will remain to repay bondholders. As an example, after an accounting scandal and a
Chapter 11 Chapter 11 of the United States Bankruptcy Code (Title 11 of the United States Code Title 11 of the United States Code, also known as the United States Bankruptcy Code, is the source of Bankruptcy in the United States, bankruptcy law in the Uni ...
bankruptcy at the giant telecommunications company
Worldcom MCI, Inc. (subsequently Worldcom and MCI WorldCom) was a telecommunication Telecommunication is the transmission of information by various types of technologies over wire, radio, Optical system, optical, or other Electromagnetism, elect ...
, in 2004 its bondholders ended up being paid 35.7 cents on the dollar. In a bankruptcy involving reorganization or recapitalization, as opposed to liquidation, bondholders may end up having the value of their bonds reduced, often through an exchange for a smaller number of newly issued bonds. * Some bonds are callable, meaning that even though the company has agreed to make payments plus interest towards the debt for a certain period of time, the company can choose to pay off the bond early. This creates reinvestment risk, meaning the investor is forced to find a new place for their money, and the investor might not be able to find as good a deal, especially because this usually happens when interest rates are falling.


Bond indices

A number of bond indices exist for the purposes of managing portfolios and measuring performance, similar to the
S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of D ...
or Russell Indexes for
stock In finance, stock (also capital stock) consists of all the Share (finance), shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which owners ...
s. The most common American benchmarks are the Bloomberg Barclays US Aggregate (ex Lehman Aggregate), Citigroup BIG and Merrill Lynch Domestic Master. Most indices are parts of families of broader indices that can be used to measure global bond portfolios, or may be further subdivided by maturity or sector for managing specialized portfolios.


See also

*
Bond credit rating In investment, the bond credit rating represents the credit worthiness of corporate or government bond (finance), bonds. It is not the same as an individual's credit score. The ratings are published by Credit rating agency, credit rating agencies ...
* Collective action clause *
Debenture In corporate finance, a debenture is a medium- to long-term debt financial instrument, instrument used by large companies to borrow money, at a fixed rate of interest. The legal term "debenture" originally referred to a document that either creat ...
* Deferred financing costs * GDP-linked bond *
Government bond A government bond or sovereign bond is a form of bond issued by a government A government is the system or group of people governing an organized community, generally a state. In the case of its broad associative definition, go ...
/ Sovereign bonds * Immunization (finance) *
Promissory note A promissory note, sometimes referred to as a note payable, is a legal instrument (more particularly, a financing instrument and a debt instrument), in which one party (the ''maker'' or ''issuer'') promises in writing to pay a determinate sum of ...
* Short-rate model * Penal bond * Structured note Market specific * Brady Bonds *
Build America Bonds Build America Bonds are taxable municipal bond A municipal bond, commonly known as a muni, is a bond issued by state or local governments, or entities they create such as authorities and special districts. In the United States, interest income r ...
* Eurobond General *
Fixed income Fixed income refers to any type of investment under which the borrower or issuer is obliged to make payments of a fixed amount on a fixed schedule. For example, the borrower may have to pay interest at a fixed rate once a year and repay the prin ...
*
List of accounting topics This page is an index of accounting topics. {{AlphanumericTOC, align=center, nobreak=, numbers=, references=, externallinks=, top=} A Accounting ethics - Accounting information system An accounting as an information system (AIS) i ...
* List of economics topics *
List of finance topics The following Outline (list), outline is provided as an overview of and topical guide to finance: Finance – addresses the ways in which individuals and organizations raise and allocate monetary factors of production, resources over time, ta ...


References


External links

*
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Disadvantages of Bond
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An ultimate judgment of which better profitable bonds or stocks. {{DEFAULTSORT:Bond (Finance)