Bonds & Fixed Income

A bond is a debt instrument (an IOU). By buying it, the investor LENDS money to the issuer and becomes a CREDITOR — unlike a shareholder, who is a part-owner. This is the fundamental debt-versus-equity distinction.

In return the issuer promises two things: to pay periodic INTEREST (the coupon) over the life of the bond, and to repay the PRINCIPAL (the face/par value) at maturity.

Because a bondholder's claim is contractual debt, it ranks AHEAD of shareholders if the issuer is wound up. Bonds are generally regarded as lower-risk than the same issuer's shares, though they are not risk-free.

Bonds are usually tradable in a secondary market before maturity, so their market price can rise or fall — an investor need not hold to maturity, but the sale price is not guaranteed.

A 'plain-vanilla' (straight) bond is the simplest form. Its defining features are:

• •FACE VALUE (par / principal / nominal): the amount printed on the bond that the issuer repays at maturity, and the base on which the coupon is calculated.
• •COUPON: the periodic interest payment. The COUPON RATE is expressed as an annual percentage of face value; the cash coupon = coupon rate × face value. Coupons are typically paid annually or semi-annually.
• •MATURITY (redemption) DATE: the fixed date on which the bond expires and the face value is repaid. The remaining time to that date is the bond's 'term' or 'tenor'.
• •ISSUE PRICE and REDEMPTION: the bond may be issued at par, at a discount (below par) or at a premium (above par); a plain-vanilla bond is normally redeemed at par.

The coupon rate is FIXED for the life of a plain-vanilla bond, so the cash interest does not change even as market interest rates and the bond's market price move.

Example of the mechanics only: a bond with a face value of 1,000 and a 5% annual coupon pays 50 of interest each year and repays the 1,000 at maturity — regardless of what its market price does in between.