Section 4.1 Introduction to Bonds
A bond is a financial instrument that is often utilized to finance capital needs. Indeed, the lender often utilizes the sale of such an instrument to invest in long-term productivity-increasing items. Indeed, the bond often requires that the issuer of the bond utilized the bond proceeds for some designated project. In return for the money paid to purchase the bond, the purchaser (bond-holder) if promised the principle back plus interest. The rate of interest charged is often fixed but can also be variable.
Some terms:
- Maturity Value = Promised repayment future value
- Coupon = Percentage of annual interest paid during the time span of the bond.
- Price = Present Value of the Bond's Maturity Value
- Yield = Total Interest Earned
- Par Bonds = An instrument in which yield equals coupon.
- Discount Bonds = An instrument in which the yield is greater than the coupon.
- Premium Bonds = An instrument in which the yield is less than the coupon.
- Capital Appreciation Bonds = An instrument which pays no interest until maturity.
- Callable Bonds = An instrument which can be redeemed by the issuer before the actual maturity date.
- Basis Point = one hundredth of one percent yield.
Price and Yield vary in opposite directions. As the price of a bond increases, the difference between price and maturity value diminishes and therefore yield goes down. As the price decreases, the difference increases and therefore yield goes up.
Fixed rate bonds generally presume a 360-day year. Variable rate bonds presume actual days elapsed.