What is a Bond?
A Bond is a loan given to an issuer (borrower) by a bondholder (lender). The issuer borrows funds for a defined period of time at a variable or fixed interest rate and pays the bondholder interest on the amount borrowed. On expiry, the bondholder is paid the principal amount back.
Terminology:
- Face/Par Value is the basic denomination of a bond. This is amount returned to an investor at the time of maturity.
For example, the face value of a bond is Rs.1000. Ms Mary buys it at a premium of Rs.1,080 per unit. Mr Joseph buys units later when it is trading at Rs. 980. When the bond matures, both investors will receive Rs. 1,000 per unit. - Principal Amount is the total amount invested by a bondholder in a particular bond.
For example, Mr Sanoj purchases 10 units of a bond with a face value of Rs.1000 each. Hence, his principal investment amount is Rs. 10,000. - Coupon Rate is the periodic rate of interest paid by the issuer to the bondholders. It is calculated on the face value of the bond and is expressed as a percentage.
For example, the face value of a bond is Rs. 1,000 with a coupon rate of 5%. Hence, bondholders will receive Rs. 50 per unit as interest every year (5% x 1,000). - A bond is said to be at a Discount/Premium when it is trading below/above its face value.
- Maturity Date is the date the issuer has to repay the entire borrowed amount to the bondholder.
- Yield to Maturity (YTM) is the total return that an investor will earn on a bond if held from the investment date until the maturity date. It is expressed as a percentage. This is not necessarily the same as the coupon rate and is dependent on the price at which the investor has purchased the bond.
Yield to Maturity = [Annual Interest + {(Face Value-Price)/Maturity}] / [(Face Value+Price)/2]
For example,
| Bond Feature | Value |
|---|---|
| Face Value | Rs. 1,000 |
| Annual Coupon Rate | 10% |
| Annual Interest Payout | Rs. 100 |
| Current Market Value/Price | Rs. 1,200 |
| Current Market Value/Price | 5 Years |
YTM of the bond = [100 + {(1,000 - 1,200) / 5}] / [(1,000 + 1,200) / 2] * 100 = 5.45 %
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