Bonds - The six bond terms everybody should know

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Coupon rate

When you invest an amount in a bond, you are in a way lending money to the issuer and, hence, get an interest on the amount. Coupon rate is the interest you get on the principal amount invested. Usually, this is specified at the time of purchase and paid on an annual or semi-annual basis.

Face value

Simply put, this is the value printed on the face of the bond. It is also know as par value. This value is the maturity or principal amount per bond, which the issuer of the bond agreed to pay the investor. Usually face value is of Rs. 100, but there are bonds with higher face value as well, for instance, Rs. 1,000.

Current yield

It is the annual rate of return on the bond price. This is not the same as the coupon rate and the term is used for bonds that are traded and have a market price. The current yield is essentially calculated as the annual coupon divided by the current market price. The yield is more than the coupon if the market price is less than the face value and vice-versa. For example, if a 12.50% bond sells for Rs. 105.50, the current yield will be 11.84% (annual coupon receipt/market price of the bond).

Interest rate risk

Like every investment, bonds too carry different types of risks. A bond carries interest rate risk owing to fluctuation in rates. Keep in mind that interest rates and bond prices are inversely proportional: as interest rates increase, the price of the bond falls. This risk can affect you only if you exit a bond before maturity; on maturity, you get the promised coupon rate.

Yield to maturity (YTM)

As mentioned above, yield is the current annualized earning from a bond measured with respect to its current price. In this case, YTM is specified at the time of issue and is the rate of interest you will get if you hold the bond until maturity. YTM is made up of two things—the coupon payments and the maturity amount. Any change in this yield will mean a change in the price of the bond inversely. Yield spread The difference between current yield of two bonds is called bond spread. it can be calculated as the difference in yield of a corporate and government bond and also as the difference in yield for two bonds with different credit ratings.

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