There was a time when bonds were the primary means of financing and raising capital. Bond markets date back to ancient times; farmers in Mesopotamia would issue bonds to give merchants an opportunity to borrow produce. Later, sovereign rulers financed military invasions through bonds when revenue from taxation was not enough. During World War II, many investors amassed wealth through as traders of U.S. war bonds.
Long before equity securities were traded on public exchanges, companies issued bonds for various purposes. When compared to stocks, bonds are financial instruments of greater complexity. When investors purchase bonds, they do not acquire any equity; instead, they hold a marketable promise of debt repayment. Bonds can be issued by governments, municipalities, utilities, corporations, and investment banking firms.
Although bonds can be structured in various manners, most of them will share the following features:
<strong>Face Value</strong>
The face value of a bond is also known as its principal or par value, which represents the monetary amount that investors must pay to acquire the instrument; in other words, the face value is the price of the bond.
<strong>Yield</strong>
This is the rate of interest that the issuer promises to pay on a quarterly or annually basis. The yield is also known as the coupon; in the case of zero-coupon bonds, the financial advantage to investors is that they can purchase bonds at a lower face value. The yield can be fixed, variable or pegged to a benchmark index such as the London Interbank Offered Rate, better known as LIBOR.
<strong>Maturity</strong>
The term of a bond expires at the maturity rate, at which point the issuer must collect all bond certificates and return the principal to holders.
<strong>Rating</strong>
Market research companies such as Moody’s, Fitch and S&P review bond offerings and issue ratings based on the quality of the investment. The ratings start at AAA, which denotes sure bets, and bottom out at CCC, which indicates a high risk.
<strong>Calculating the Yield and Market Value of Bonds</strong>
Investors must take note of the bond yield when they acquire the certificate. To calculate how much the yield is worth on a bond that pays an annual interest rate, this rate must be divided by the face value.
Let’s say an investor pays $1,000 for a corporate bond rated AAA that matures in a year and pays a five percent annual rate of interest; in this case, the yield would be $50, and the investor would be able to collect a total of $1,050 upon maturity.
The true value of bonds can be determined through various calculations; however, it is more important to consider supply and demand. Bonds can be traded in a manner similar to stocks; in fact, not many investment banking firms and fund managers will wait around for coupon payments to be made. Bond market listings will indicate the true market value of bonds, which can be purchased at par, premium or discount prices.
Since bond prices fluctuate based on market conditions and ratings, investors will have an opportunity to profit from taking positions on the market. Bonds can be traded on online brokerage platforms for a fee.
Jim Treebold is a North Carolina based writer. He lives by the mantra of “Learn 1 new thing each day”! Jim loves to write, read, pedal around on his electric bike and dream of big things. Drop him a line if you like his writing, he loves hearing from his readers!