fixed income security
The features of a fixed-income security include specification of:
- The issuer of the bond.
- The maturity date of the bond.
- The par value (principal value to be repaid).
- Coupon rate and frequency.
- Currency in which payments will be made.
Issuers of Bonds
There are several types of entities that issue bonds when they borrow money, including:
- Corporations. Often corporate bonds are divided into those issued by financial companies and those issued by nonfinancial companies.
- Sovereign national governments. A prime example is U.S. Treasury bonds, but many countries issue sovereign bonds.
- Non-sovereign governments. Issued by government entities that are not national governments, such as the state of California or the city of Toronto.
- Quasi-government entities. Not a direct obligation of a country’s government or central bank. An example is the Federal National Mortgage Association (Fannie Mae).
- Supranational entities. Issued by organizations that operate globally such as the World Bank, the European Investment Bank, and the International Monetary Fund (IMF).
- Special purpose entities. These are corporations set up to purchase financial assets and issue asset-backed securities, which are bonds backed by the cash flows from those assets.
Bond Maturity
The maturity date of a bond is the date on which the principal is to be repaid. Once a bond has been issued, the time remaining until maturity is referred to as the term to maturity or tenor of a bond.
When bonds are issued, their terms to maturity range from one day to 30 years or more. Both Disney and Coca-Cola have issued bonds with original maturities of 100 years. Bonds that have no maturity date are called perpetual bonds. They make periodic interest payments but do not promise to repay the principal amount.
Bonds with original maturities of one year or less are referred to as money market securities. Bonds with original maturities of more than one year are referred to as capital market securities.
par value
The par value of a bond is the principal amount that will be repaid at maturity. The par value is also referred to as the face value, maturity value, redemption value, or principal value of a bond. Bonds can have a par value of any amount, and their prices are quoted as a percentage of par. A bond with a par value of $1,000 quoted at 98 is selling for $980.
A bond that is selling for more than its par value is said to be trading at a premium to par; a bond that is selling at less than its par value is said to be trading at a discount to par; and a bond that is selling for exactly its par value is said to be trading at par.
Coupon Payments
The coupon rate on a bond is the annual percentage of its par value that will be paid to bondholders. Some bonds make coupon interest payments annually, while others make semiannual, quarterly, or monthly payments. A $1,000 par value semiannual-pay bond with a 5% coupon would pay 2.5% of $1,000, or $25, every six months. A bond with a fixed coupon rate is called a plain vanilla bond or a conventional bond.
Some bonds pay no interest prior to maturity and are called zero-coupon bonds or pure discount bonds. Pure discount refers to the fact that these bonds are sold at a discount to their par value and the interest is all paid at maturity when bondholders receive the par value. A 10- year, $1,000, zero-coupon bond yielding 7% would sell at about $500 initially and pay $1,000 at maturity. We discuss various other coupon structures later in this reading.
Currencies
Bonds are issued in many currencies. Sometimes borrowers from countries with volatile currencies issue bonds denominated in euros or U.S. dollars to make them more attractive to a wide range of investors. A dual-currency bond makes coupon interest payments in one currency and the principal repayment at maturity in another currency. A currency option bond gives bondholders a choice of which of two currencies they would like to receive their payments in