A bond is a debt instrument used by corporations, governments or municipals to borrow from many people at one time in order to raise their financial capital. They are a promise by the issuer to pay you back the principal amount you used to purchase the bond and interest every year until the maturity date. These instruments are offered in terms of their durations e.g. 5-year bonds and 10-year bonds, and offer a fixed interest rate that is payable every period. Here’s a look terms associated with bonds:

Face/Par value: This is the amount at which the bond is offered to investors and represents the amount payable when the security matures. In some cases, a minimum is offered to investors with additional amounts made available in batches. For example, a minimum of KES 100,000 is required with additional amounts to be bought in batches of KES 20,000.

Maturity date: This refers to the date at which the principal amount will be paid back to the bond holder.

Coupon rate: This is the fixed interest rate that the bond will earn at the end of each period, that is payable to the holder. For example, a 10% p.a. 5-year bond will earn the holder 10% interest payable at the end of every year until the 5 years have lapsed.

Coupon: It refers to the amount payable to the bond holder that is based on the coupon rate and the principal value of the bond. The term “coupon” is normally used interchangeably with “coupon rate” but is not to be confused regardless of the context. Assuming the 5-year bond in the example above has a face value of KES 250,000 then the coupon rate is 10% and the coupon is KES 25,000. Bonds are normally offered in terms of their duration and coupon rate. The coupons however depend on the investor’s principal value. For the same period and coupon rate as above, another investor may purchase at KES 300,000 making their coupon KES 30,000.

Yield-To-Maturity (YTM): This is a rate of return an investor expects to get from a bond from the time they purchase it (at the current price then) until the maturity date. It takes into account the coupon expected at the end of each period and the par value expected on maturity date.

Default/credit risk: It is the risk that the issuer of the bond will not be able to make due payments of the coupon or the face value in a timely manner. This risk is higher for issuers that don’t have good credit ratings (or credibility) and those that deal with a large number of liabilities. A default by the issuer usually results in partial or total loss of the holder’s money.

This is part of a series that will run for 2 months with the information one will need to equip themselves with regarding bonds.

Next Week: History of Bonds