Basics on Bonds

What you should know

Bonds are fixed income investments that have a fixed interest rate or coupon payable on the principal amount, usually $100.

There are many different types of fixed income investments:

Bonds Mid-term notes Debentures Mortgages Asset-backed securities Savings bonds Guaranteed investment contracts (GICs) Certificates of deposits (CDs)

Types of bonds are based on a number of factors.

How they offer payouts

Kinds of currency or assets they are based on

Their legal status

Government Bonds
Bonds issued by a government entity rather than a private issuer such as a corporation Considered safest bond to invest in Safest due to relative stability and reliability of national economies

Corporate Bonds
Similar to most bonds Differ in that they are sold to investors by independent companies instead of banks or government issuers

Advantages: allow businesses to receive investment capital without having to offer shares

Convertible Bonds
Gives the holder the right to "convert" or exchange the par amount of the bond for common shares of the issuer at some fixed ratio during a particular period Conversion feature also gives them features of equity securities

Foreign Currency Bonds

A bond that is issued by an issuer in a currency other than its national currency
Different currencies make them more attractive to buyers as they can take advantage of international interest rate differentials Can be "swapped" or converted in the swap market into the home currency of the issuer

Junk Bonds
Get their name from their characteristics junk

Bonds issued by a company that is considered to be a higher credit risk

Chance of default with junk bonds is higher than for other types of bonds

Extendable and Retractable Bonds

Have more than one maturity date

Extendible: gives its holder the right to extend the initial maturity to a longer maturity date
Retractable: gives its holder the right to advance the return of principal to an earlier date than the original maturity

Inflation-Linked Bonds
Bond that provides protection against inflation Most are principle indexed

This means that their principal is increased by the change in inflation over a period

Zero Coupon Bonds

A fixed income security that is created from the cash flows that make up a normal bond Similar to a Treasury Bill or "T-Bill".

This means the investor pays something up front in exchange for a promise to receive $100 on the maturity date

Mortgage-Backed Security
A security that is based on a pool of underlying mortgages Based on mortgages that are guaranteed by a government agency for payment of principal and a guarantee of timely payment Concentrates on the nature of the underlying payment stream, particularly the prepayments of principal prior to maturity

Asset-Backed Securities
Bonds that are based on underlying pools of assets A special purpose trust or instrument is set up which takes title to the assets and the cash flows are "passed through" to the investors in the form of an asset-backed security Types of assets that can be "securitized" range from residential mortgages to credit card receivables

The value of a bond depends on the size of its coupon payments, the length of time remaining until the bond matures, and the current level of interest rate.

Bond Trading is an important aspect of global economic markets. Bonds generally can trade anywhere in the world that a buyer and seller can strike a deal. There is no central place or exchange for bond trading, as there is for publicly traded stocks.

Bond Terminology

Coupon
The percentage interest to be paid on a bond in the course of a year. The interest is usually payable semi-annually, although it can also be payable monthly, quarterly, and annually

Maturity
The date the bond will be redeemed or paid off

Price
The quoted price is usually based on the bond maturity at a price of par, or 100.00

Yield
The term "yield" usually means "yield to maturity." The yield to maturity takes into account the coupon payment, and considers whether the bond is maturing at a different price than its current price

For more financial education regarding bonds, visit www.finpipe.com