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In finance, a bond is a type of
security" \n\n\nsecurity.txt is a proposed standard for websites' security information that is meant to allow security researchers to easily report security vulnerabilities. The standard prescribes a text file called \"security.txt\" in the well known locat ...
under which the issuer ( debtor) owes the holder ( creditor) a
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...
, and is obliged – depending on the terms – to repay the principal (i.e. amount borrowed) of the bond at the
maturity date Maturity or immaturity may refer to: * Adulthood or age of majority * Maturity model ** Capability Maturity Model, in software engineering, a model representing the degree of formality and optimization of processes in an organization * Developmen ...
as well as interest (called the
coupon In marketing, a coupon is a ticket or document that can be redeemed for a financial discount or rebate when purchasing a product. Customarily, coupons are issued by manufacturers of consumer packaged goods or by retailers, to be used in r ...
) over a specified amount of time. The interest is usually payable at fixed intervals: semiannual, annual, and less often at other periods. Thus, a bond is a form of
loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that ...
or IOU. Bonds provide the borrower with external funds to finance long-term investments or, in the case of
government bond A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments'','' and to repay the face value on the maturity dat ...
s, to finance current expenditure. Bonds and stocks are both
securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
, but the major difference between the two is that (capital)
stockholder A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a trust or partnership) that is registered by the corporation as the legal own ...
s have an equity stake in a company (i.e. they are owners), whereas bondholders have a creditor stake in a company (i.e. they are lenders). As creditors, bondholders have priority over stockholders. This means they will be repaid in advance of stockholders, but will rank behind
secured creditor A secured creditor is a creditor with the benefit of a security interest over some or all of the assets of the debtor. In the event of the bankruptcy of the debtor, the secured creditor can enforce security against the assets of the debtor and av ...
s, in the event of bankruptcy. Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks typically remain outstanding indefinitely. An exception is an irredeemable bond, which is a perpetuity, that is, a bond with no maturity.
Certificates of deposit A certificate of deposit (CD) is a time deposit, a financial product commonly sold by banks, thrift institutions, and credit unions in the United States. CDs differ from savings accounts in that the CD has a specific, fixed term (often one, t ...
(CDs) or short-term
commercial paper Commercial paper, in the global financial market, is an unsecured promissory note with a fixed maturity of rarely more than 270 days. In layperson terms, it is like an " IOU" but can be bought and sold because its buyers and sellers have some ...
are classified as
money market The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less. As short-term securities became a commodity, the money market became a compon ...
instruments and not bonds: the main difference is the length of the term of the instrument. The most common forms include
municipal A municipality is usually a single administrative division having corporate status and powers of self-government or jurisdiction as granted by national and regional laws to which it is subordinate. The term ''municipality'' may also mean the go ...
,
corporate A corporation is an organization—usually a group of people or a company—authorized by the state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal context) and r ...
, and government bonds. Very often the bond is negotiable, that is, the ownership of the instrument can be transferred in the secondary market. This means that once the transfer agents at the bank medallion-stamp the bond, it is highly liquid on the secondary market. The price of a bond in the secondary market may differ substantially from the principal due to various factors in
bond valuation Bond valuation is the determination of the fair price of a bond. As with any security or capital investment, the theoretical fair value of a bond is the present value of the stream of cash flows it is expected to generate. Hence, the value of a ...
.


Etymology

In English, the word "" relates to the etymology of "bind". The use of the word "bond" in this sense of an "instrument binding one to pay a sum to another" dates from at least the 1590s.


Issuance

Bonds are issued by public authorities, credit institutions, companies and supranational institutions in the primary markets. The most common process for issuing bonds is through
underwriting Underwriting (UW) services are provided by some large financial institutions, such as banks, insurance companies and investment houses, whereby they guarantee payment in case of damage or financial loss and accept the financial risk for liabili ...
. When a bond issue is underwritten, one or more securities firms or banks, forming a
syndicate A syndicate is a self-organizing group of individuals, companies, corporations or entities formed to transact some specific business, to pursue or promote a shared interest. Etymology The word ''syndicate'' comes from the French word ''syndicat ...
, buy the entire issue of bonds from the issuer and resell them to investors. The security firm takes the risk of being unable to sell on the issue to end investors. Primary issuance is arranged by '' bookrunners'' who arrange the bond issue, have direct contact with investors and act as advisers to the bond issuer in terms of timing and price of the bond issue. The bookrunner is listed first among all underwriters participating in the issuance in the tombstone ads commonly used to announce bonds to the public. The bookrunners' willingness to underwrite must be discussed prior to any decision on the terms of the bond issue as there may be limited demand for the bonds. In contrast, government bonds are usually issued in an auction. In some cases, both members of the public and banks may bid for bonds. In other cases, only market makers may bid for bonds. The overall rate of return on the bond depends on both the terms of the bond and the price paid. The terms of the bond, such as the coupon, are fixed in advance and the price is determined by the market. In the case of an underwritten bond, the underwriters will charge a fee for underwriting. An alternative process for bond issuance, which is commonly used for smaller issues and avoids this cost, is the private placement bond. Bonds sold directly to buyers may not be tradeable in the
bond market The bond market (also debt market or credit market) is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities, known as the secondary market. This is usually in the form of bonds, bu ...
. Historically, an alternative practice of issuance was for the borrowing government authority to issue bonds over a period of time, usually at a fixed price, with volumes sold on a particular day dependent on market conditions. This was called a ''tap issue'' or ''bond tap''.


Features


Principal

Nominal, principal, par, or face amount is the amount on which the issuer pays interest, and which, most commonly, has to be repaid at the end of the term. Some structured bonds can have a redemption amount which is different from the face amount and can be linked to the performance of particular assets.


Maturity

The issuer is obligated to repay the nominal amount on the maturity date. As long as all due payments have been made, the issuer has no further obligations to the bond holders after the maturity date. The length of time until the maturity date is often referred to as the term or tenor or maturity of a bond. The maturity can be any length of time, although debt securities with a term of less than one year are generally designated money market instruments rather than bonds. Most bonds have a term shorter than 30 years. Some bonds have been issued with terms of 50 years or more, and historically there have been some issues with no maturity date (irredeemable). In the market for United States Treasury securities, there are four categories of bond maturities: * short term (bills): maturities between zero and one year; * medium term (notes): maturities between one and ten years; * long term (bonds): maturities between ten and thirty years; * Perpetual: no maturity Period.


Coupon

The
coupon In marketing, a coupon is a ticket or document that can be redeemed for a financial discount or rebate when purchasing a product. Customarily, coupons are issued by manufacturers of consumer packaged goods or by retailers, to be used in r ...
is the interest rate that the issuer pays to the holder. For
fixed rate bond Fixed may refer to: * ''Fixed'' (EP), EP by Nine Inch Nails * ''Fixed'', an upcoming 2D adult animated film directed by Genndy Tartakovsky * Fixed (typeface), a collection of monospace bitmap fonts that is distributed with the X Window System * F ...
s, the coupon is fixed throughout the life of the bond. For floating rate notes, the coupon varies throughout the life of the bond and is based on the movement of a
money market The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less. As short-term securities became a commodity, the money market became a compon ...
reference rate (often LIBOR). Historically, coupons were physical attachments to the paper bond certificates, with each coupon representing an interest payment. On the interest due date, the bondholder would hand in the coupon to a bank in exchange for the interest payment. Today, interest payments are almost always paid electronically. Interest can be paid at different frequencies: generally semi-annual (every 6 months) or annual.


Yield

The yield is the rate of return received from investing in the bond. It usually refers to one of the following: * The current yield, or running yield: the annual interest payment divided by the current market price of the bond (often the clean price). * The
yield to maturity The yield to maturity (YTM), book yield or redemption yield of a bond or other fixed-interest security, such as gilts, is an estimate of the total rate of return anticipated to be earned by an investor who buys a bond at a given market price, h ...
(or redemption yield, as it is termed in the United Kingdom) is an estimate of the total rate of return anticipated to be earned by an investor who buys a bond at a given market price, holds it to maturity, and receives all interest payments and the capital redemption on schedule. It is a more useful measure of the return on a bond than current yield because it takes into account the
present value In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has inte ...
of future interest payments and principal repaid at maturity. The yield to maturity or redemption yield calculated at the time of purchase is not necessarily the return the investor will actually earn, as finance scholars Dr. Annette Thau and Dr.
Frank Fabozzi Frank J. Fabozzi is an American economist, educator, writer, and investor, currently Professor of Practice at The Johns Hopkins University Carey Business School and a Member of Edhec Risk Institute. He was previously a Professor of Finance at EDHE ...
have noted. The yield to maturity will be realized only under certain conditions, including: 1) all interest payments are reinvested rather than spent, and 2) all interest payments are reinvested at the yield to maturity calculated at the time the bond is purchased. This distinction may not be a concern to bond buyers who intend to spend rather than reinvest the coupon payments, such as those practicing asset/liability matching strategies.


Credit quality

The quality of the issue refers to the probability that the bondholders will receive the amounts promised at the due dates. In other words, credit quality tells investors how likely the borrower is going to default. This will depend on a wide range of factors.
High-yield bond In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade by credit rating agencies. These bonds have a higher risk of default or other adverse credit events ...
s are bonds that are rated below investment grade by the
credit rating agencies A credit rating agency (CRA, also called a ratings service) is a company that assigns credit ratings, which rate a debtor's ability to pay back debt by making timely principal and interest payments and the likelihood of default. An agency may ra ...
. As these bonds are riskier than investment grade bonds, investors expect to earn a higher yield. These bonds are also called ''junk bonds''.


Market price

The market price of a tradable bond will be influenced, among other factors, by the amounts, currency and timing of the interest payments and capital repayment due, the quality of the bond, and the available redemption yield of other comparable bonds which can be traded in the markets. The price can be quoted as clean or
dirty Dirt is an unclean matter, especially when in contact with a person's clothes, skin, or possessions. In such cases, they are said to become dirty. Common types of dirt include: * Debris: scattered pieces of waste or remains * Dust: a genera ...
. "Dirty" includes the present value of all future cash flows, including accrued interest, and is most often used in Europe. "Clean" does not include accrued interest, and is most often used in the U.S. The issue price at which investors buy the bonds when they are first issued will typically be approximately equal to the nominal amount. The net proceeds that the issuer receives are thus the issue price, less issuance fees. The market price of the bond will vary over its life: it may trade at a premium (above par, usually because market interest rates have fallen since issue), or at a discount (price below par, if market rates have risen or there is a high probability of default on the bond).


Others

* Indentures and Covenants—An indenture is a formal debt agreement that establishes the terms of a bond issue, while covenants are the clauses of such an agreement. Covenants specify the rights of bondholders and the duties of issuers, such as actions that the issuer is obligated to perform or is prohibited from performing. In the U.S., federal and state securities and commercial laws apply to the enforcement of these agreements, which are construed by courts as contracts between issuers and bondholders. The terms may be changed only with great difficulty while the bonds are outstanding, with amendments to the governing document generally requiring approval by a majority (or
super-majority A supermajority, supra-majority, qualified majority, or special majority is a requirement for a proposal to gain a specified level of support which is greater than the threshold of more than one-half used for a simple majority. Supermajority ru ...
) vote of the bondholders. * Optionality: Occasionally a bond may contain an embedded option; that is, it grants option-like features to the holder or the issuer: ** Callability—Some bonds give the issuer the right to repay the bond before the maturity date on the call dates; see call option. These bonds are referred to as
callable bond A callable bond (also called redeemable bond) is a type of bond (debt security) that allows the issuer of the bond to retain the privilege of redeeming the bond at some point before the bond reaches its date of maturity. In other words, on the call ...
s. Most callable bonds allow the issuer to repay the bond at par. With some bonds, the issuer has to pay a premium, the so-called call premium. This is mainly the case for high-yield bonds. These have very strict covenants, restricting the issuer in its operations. To be free from these covenants, the issuer can repay the bonds early, but only at a high cost. ** Puttability—Some bonds give the holder the right to force the issuer to repay the bond before the maturity date on the put dates; see put option. These are referred to as retractable or putable bonds. ** Call dates and put dates—the dates on which callable and putable bonds can be redeemed early. There are four main categories: *** A Bermudan callable has several call dates, usually coinciding with coupon dates. *** A European callable has only one call date. This is a special case of a Bermudan callable. *** An American callable can be called at any time until the maturity date. *** A death put is an optional redemption feature on a debt instrument allowing the beneficiary of the estate of a deceased bondholder to put (sell) the bond back to the issuer at face value in the event of the bondholder's death or legal incapacitation. This is also known as a "survivor's option". **
Sinking fund A sinking fund is a fund established by an economic entity by setting aside revenue over a period of time to fund a future capital expense, or repayment of a long-term debt. In North America and elsewhere where it is common for public and priva ...
provision of the corporate bond indenture requires a certain portion of the issue to be retired periodically. The entire bond issue can be liquidated by the maturity date; if not, the remainder is called balloon maturity. Issuers may either pay to trustees, which in turn call randomly selected bonds in the issue, or, alternatively, purchase bonds in the open market, then return them to trustees. *** Bonds are often identified by their international securities identification number, or ISIN, which is a 12-digit alphanumeric code that uniquely identifies debt securities.


Types

Bonds can be categorised in several ways, such as the type of issuer, the currency, the term of the bond (length of time to maturity) and the conditions applying to the bond. The following descriptions are not mutually exclusive, and more than one of them may apply to a particular bond:


The nature of the issuer and the security offered

The nature of the issuer will affect the security (certainty of receiving the contracted payments) offered by the bond, and sometimes the tax treatment. *
Government bond A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments'','' and to repay the face value on the maturity dat ...
s, often also called Treasury bonds, are issued by a national government. Some countries have repeatedly defaulted on their government bonds. However the bonds issued by some national governments are sometimes treated as risk-free and not exposed to default risk. Risk-free bonds are thus the safest bonds, with the lowest interest rate. A Treasury bond is backed by the "full faith and credit" of the relevant government. However in reality most or all government bonds do carry some residual risk. This is indicated by **the award by rating agencies of a rating below the top rating, **bonds issued by different national governments, such as various member states of the European Union, all denominated in Euros, offering different market yields reflecting their different risks. * A supranational bond, also known as a "supra", is issued by a
supranational organisation A supranational union is a type of international organization that is empowered to directly exercise some of the powers and functions otherwise reserved to states. A supranational organization involves a greater transfer of or limitation of ...
like the
World Bank The World Bank is an international financial institution that provides loans and grants to the governments of low- and middle-income countries for the purpose of pursuing capital projects. The World Bank is the collective name for the Inte ...
. They have a very good credit rating, similar to that on national government bonds. * A municipal bond issued by a local authority or subdivision within a country, for example a city or a federal state. These will to varying degrees carry the backing of the national government. In the United States, such bonds are exempt from certain taxes. For example, Build America Bonds (BABs) are a form of municipal bond authorized by the
American Recovery and Reinvestment Act of 2009 The American Recovery and Reinvestment Act of 2009 (ARRA) (), nicknamed the Recovery Act, was a stimulus package enacted by the 111th U.S. Congress and signed into law by President Barack Obama in February 2009. Developed in response to the Gr ...
. Unlike traditional US municipal bonds, which are usually tax exempt, interest received on BABs is subject to federal taxation. However, as with municipal bonds, the bond is tax-exempt within the US state where it is issued. Generally, BABs offer significantly higher yields than standard municipal bonds. ** A
revenue bond A revenue bond is a special type of municipal bond distinguished by its guarantee of repayment solely from revenues generated by a specified revenue-generating entity associated with the purpose of the bonds, rather than from a tax. Unlike genera ...
is a special type of municipal bond distinguished by its guarantee of repayment solely from revenues generated by a specified revenue-generating entity associated with the purpose of the bonds. Revenue bonds are typically "non-recourse", meaning that in the event of default, the bond holder has no recourse to other governmental assets or revenues. * A
War bond War bonds (sometimes referred to as Victory bonds, particularly in propaganda) are debt securities issued by a government to finance military operations and other expenditure in times of war without raising taxes to an unpopular level. They are ...
is a bond issued by a government to fund military operations and other expenditure during wartime. Investment in such bonds may be motivated by a lack of other investment or spending opportunities, and/or by an appeal to patriotism. Thus such bonds often have a low return rate. *
High-yield bond In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade by credit rating agencies. These bonds have a higher risk of default or other adverse credit events ...
s (junk bonds) are bonds that are rated below investment grade by the
credit rating agencies A credit rating agency (CRA, also called a ratings service) is a company that assigns credit ratings, which rate a debtor's ability to pay back debt by making timely principal and interest payments and the likelihood of default. An agency may ra ...
, because they are uncertain that the issuer will be able or willing to pay the scheduled interest payments and/or redeem the bond at maturity. As these bonds are much riskier than investment grade bonds, investors expect to earn a much higher yield. * A Climate bond is a bond issued by a government or corporate entity in order to raise finance for climate change mitigation- or adaptation-related projects or programmes. For example, in 2021 the UK government started to issue "green bonds". *
Covered bond Covered bonds are debt securities issued by a bank or mortgage institution and collateralised against a pool of assets that, in case of failure of the issuer, can cover claims at any point of time. They are subject to specific legislation to protect ...
s are backed by cash flows from mortgages or public sector assets. Unlike asset-backed securities, the assets for such bonds remain on the issuer's balance sheet. * Asset-backed securities are bonds whose interest and principal payments are backed by underlying cash flows from other assets. Examples of asset-backed securities are
mortgage-backed securities A mortgage-backed security (MBS) is a type of asset-backed security (an 'instrument') which is secured by a mortgage or collection of mortgages. The mortgages are aggregated and sold to a group of individuals (a government agency or investment ba ...
(MBSs), collateralized mortgage obligations (CMOs), and
collateralized debt obligation A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS). Originally developed as instruments for the corporate debt markets, after 2002 CDOs became vehicles for refinancing mortgage-backed securities (MBS).Le ...
s (CDOs). * Subordinated bonds are those that have a lower priority than other bonds of the issuer in case of liquidation. In case of bankruptcy, there is a hierarchy of creditors. First the liquidator is paid, then government taxes, etc. The first bond holders in line to be paid are those holding what are called senior bonds. After they have been paid, the subordinated bond holders are paid. As a result, the risk is higher. Therefore, subordinated bonds usually have a lower credit rating than senior bonds. The main examples of subordinated bonds can be found in bonds issued by banks and asset-backed securities. The latter are often issued in
tranche In structured finance, a tranche is one of a number of related securities offered as part of the same transaction. In the financial sense of the word, each bond is a different slice of the deal's risk. Transaction documentation (see indenture) ...
s. The senior tranches get paid back first, the subordinated tranches later. * Social impact bonds are an agreement for public sector entities to pay back private investors after meeting verified improved social outcome goals that result in public sector savings from innovative social program pilot projects.


The term of the bond

* Most bonds are structured to mature on a stated date, when the principal is due to be repaid, and interest payments cease. Typically, a bond with term to maturity of under five years would be called a short bond; 5 to 15 years would be "medium", and over 15 years would be "long"; but the numbers may vary in different markets. *
Perpetual bond A perpetual bond, also known colloquially as a perpetual or perp, is a bond with no maturity date, therefore allowing it to be treated as equity, not as debt. Issuers pay coupons on perpetual bonds forever, and they do not have to redeem the pr ...
s are also often called perpetuities or 'Perps'. They have no maturity date. Historically the most famous of these were the UK Consols (there were also some other perpetual UK government bonds, such as War Loan, Treasury Annuities and undated Treasuries). Some of these were issued back in 1888 or earlier. There had been insignificant quantities of these outstanding for decades, and they have now been fully repaid. Some ultra-long-term bonds (sometimes a bond can last centuries: West Shore Railroad issued a bond which matures in 2361 (i.e. 24th century)) are virtually perpetuities from a financial point of view, with the current value of principal near zero. * The ''Methuselah'' is a type of bond with a maturity of 50 years or longer. The term is a reference to
Methuselah Methuselah () ( he, מְתוּשֶׁלַח ''Məṯūšélaḥ'', in pausa ''Məṯūšālaḥ'', "His death shall send" or "Man of the javelin" or "Death of Sword"; gr, Μαθουσάλας ''Mathousalas'') was a biblical patriarch and a f ...
, the oldest person whose age is mentioned in the
Hebrew Bible The Hebrew Bible or Tanakh (;"Tanach"
'' pension plans, particularly in
France France (), officially the French Republic ( ), is a country primarily located in Western Europe. It also comprises of overseas regions and territories in the Americas and the Atlantic, Pacific and Indian Oceans. Its metropolitan area ...
and the
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the European mainland, continental mainland. It comprises England, Scotlan ...
. Issuance of Methuselahs in the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territori ...
has been limited, however: the
U.S. Treasury The Department of the Treasury (USDT) is the national treasury and finance department of the federal government of the United States, where it serves as an executive department. The department oversees the Bureau of Engraving and Printing and t ...
does not currently issue Treasuries with maturities beyond 30 years, which would serve as a reference level for any
corporate A corporation is an organization—usually a group of people or a company—authorized by the state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal context) and r ...
issuance. *
Serial bond Serial bonds are Bond (finance), financial bonds that mature in installments over a period of time. In effect, a $100,000, 5-year serial bond (finance), bond would mature in a $20,000 Annuity (finance theory), annuity over a 5-year interval. These ...
is a bond that matures in installments over a period of time. In effect, a $100,000, 5-year serial bond would mature in a $20,000 annuity over a 5-year interval.


The conditions applying to the bond

* Fixed rate bonds have interest payments ("coupon"), usually semi-annual, that remains constant throughout the life of the bond. Other variations include stepped-coupon bonds, whose coupon increases during the life of the bond. * Floating rate notes (FRNs, floaters) have a variable coupon that is linked to a reference rate of interest, such as Libor or Euribor. For example, the coupon may be defined as three-month USD LIBOR + 0.20%. The coupon rate is recalculated periodically, typically every one or three months. * Zero-coupon bonds (zeros) pay no regular interest. They are issued at a substantial discount to
par value Par value, in finance and accounting, means stated value or face value. From this come the expressions at par (at the par value), over par (over par value) and under par (under par value). Bonds A bond selling at par is priced at 100% of face valu ...
, so that the interest is effectively rolled up to maturity (and usually taxed as such). The bondholder receives the full principal amount on the redemption date. An example of zero coupon bonds is Series E savings bonds issued by the U.S. government. Zero-coupon bonds may be created from fixed rate bonds by a financial institution separating ("stripping off") the coupons from the principal. In other words, the separated coupons and the final principal payment of the bond may be traded separately. See IO (Interest Only) and PO (Principal Only). *
Inflation-indexed bond Daily inflation-indexed bonds (also known as inflation-linked bonds or colloquially as linkers) are bonds where the principal is indexed to inflation or deflation on a daily basis. They are thus designed to hedge the inflation risk of a bond. Th ...
s (linkers) (US) or index-linked bonds (UK), in which the principal amount and the interest payments are indexed to inflation. The interest rate is normally lower than for fixed rate bonds with a comparable maturity (this position briefly reversed itself for short-term UK bonds in December 2008). However, as the principal amount grows, the payments increase with inflation. The
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the European mainland, continental mainland. It comprises England, Scotlan ...
was the first sovereign issuer to issue inflation linked
gilts Gilt-edged securities are bonds issued by the UK Government. The term is of British origin, and then referred to the debt securities issued by the Bank of England on behalf of His Majesty's Treasury, whose paper certificates had a gilt (or gilde ...
in the 1980s. Treasury Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation-linked bonds issued by the U.S. government. * Other indexed bonds, for example equity-linked notes and bonds indexed on a business indicator (income, added value) or on a country's
GDP Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced and sold (not resold) in a specific time period by countries. Due to its complex and subjective nature this measure is ofte ...
. *
Lottery bond Lottery bonds are a type of government bond in which some randomly selected bonds within the issue are redeemed at a higher value than the face value of the bond. Lottery bonds have been issued by public authorities in Belgium, Ireland, Pakistan, ...
s are issued by European and other states. Interest is paid as on a traditional fixed rate bond, but the issuer will redeem randomly selected individual bonds within the issue according to a schedule. Some of these redemptions will be for a higher value than the face value of the bond.


Bonds with embedded options for the holder

* Convertible bonds let a bondholder exchange a bond to a number of shares of the issuer's common stock. These are known as hybrid securities, because they combine equity and
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...
features. * Exchangeable bonds allows for exchange to shares of a corporation other than the issuer.


Documentation and evidence of title

* A
bearer bond A bearer bond is a bond or debt security issued by a business entity such as a corporation or a government. As a bearer instrument, it differs from the more common types of investment securities in that it is unregistered—no records are kept o ...
is an official certificate issued without a named holder. In other words, the person who has the paper certificate can claim the value of the bond. Often they are registered by a number to prevent counterfeiting, but may be traded like cash. Bearer bonds are very risky because they can be lost or stolen. In some countries they were historically popular because the owner could not be traced by the tax authorities. For example, after federal income tax began in the United States, bearer bonds were seen as an opportunity to conceal income or assets. U.S. corporations stopped issuing bearer bonds in the 1960s, the U.S. Treasury stopped in 1982, and state and local tax-exempt bearer bonds were prohibited in 1983. * A registered bond is a bond whose ownership (and any subsequent purchaser) is recorded by the issuer, or by a transfer agent. It is the opposite of a
bearer bond A bearer bond is a bond or debt security issued by a business entity such as a corporation or a government. As a bearer instrument, it differs from the more common types of investment securities in that it is unregistered—no records are kept o ...
. Interest payments, and the principal upon maturity are sent to the registered owner. * A book-entry bond is a bond that does not have a paper certificate. As physically processing paper bonds and interest coupons became more expensive, issuers (and banks that used to collect coupon interest for depositors) have tried to discourage their use. Some book-entry bond issues do not offer the option of a paper certificate, even to investors who prefer them.


Retail bonds

* Retail bonds are a type of corporate bond mostly designed for ordinary investors.


Foreign currencies

Some companies, banks, governments, and other sovereign entities may decide to issue bonds in foreign currencies as the foreign currency may appear to potential investors to be more stable and predictable than their domestic currency. Issuing bonds denominated in foreign currencies also gives issuers the ability to access investment capital available in foreign markets. A downside is that the government loses the option to reduce its bond liabilities by inflating its domestic currency. The proceeds from the issuance of these bonds can be used by companies to break into foreign markets, or can be converted into the issuing company's local currency to be used on existing operations through the use of foreign exchange swap hedges. Foreign issuer bonds can also be used to hedge foreign exchange rate risk. Some foreign issuer bonds are called by their nicknames, such as the "samurai bond". These can be issued by foreign issuers looking to diversify their investor base away from domestic markets. These bond issues are generally governed by the law of the market of issuance, e.g., a samurai bond, issued by an investor based in Europe, will be governed by Japanese law. Not all of the following bonds are restricted for purchase by investors in the market of issuance.


Bond valuation

The market price of a bond is the
present value In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has inte ...
of all expected
future interest In property law and real estate, a future interest is a legal right to property ownership that does not include the right to present possession or enjoyment of the property. Future interests are created on the formation of a defeasible estate; t ...
and principal payments of the bond, here discounted at the bond's
yield to maturity The yield to maturity (YTM), book yield or redemption yield of a bond or other fixed-interest security, such as gilts, is an estimate of the total rate of return anticipated to be earned by an investor who buys a bond at a given market price, h ...
(i.e.
rate of return In finance, return is a profit on an investment. It comprises any change in value of the investment, and/or cash flows (or securities, or other investments) which the investor receives from that investment, such as interest payments, coupons, cas ...
). That relationship is the definition of the redemption yield on the bond, which is likely to be close to the current market interest rate for other bonds with similar characteristics, as otherwise there would be arbitrage opportunities. The yield and price of a bond are inversely related so that when market interest rates rise, bond prices fall and vice versa. For a discussion of the mathematics see
Bond valuation Bond valuation is the determination of the fair price of a bond. As with any security or capital investment, the theoretical fair value of a bond is the present value of the stream of cash flows it is expected to generate. Hence, the value of a ...
. The bond's market price is usually expressed as a percentage of nominal value: 100% of face value, "at par", corresponds to a price of 100; prices can be above par (bond is priced at greater than 100), which is called trading at a premium, or below par (bond is priced at less than 100), which is called trading at a discount. The
market price A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the ...
of a bond may be quoted including the accrued interest since the last coupon date. (Some bond markets include accrued interest in the trading price and others add it on separately when settlement is made.) The price including accrued interest is known as the "full" or "
dirty price Dirt is an unclean matter, especially when in contact with a person's clothes, skin, or possessions. In such cases, they are said to become dirty. Common types of dirt include: * Debris: scattered pieces of waste or remains * Dust: a genera ...
". (''See also'' Accrual bond.) The price excluding accrued interest is known as the "flat" or " clean price". Most government bonds are denominated in units of $1000 in the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territori ...
, or in units of £100 in the
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the European mainland, continental mainland. It comprises England, Scotlan ...
. Hence, a deep discount US bond, selling at a price of 75.26, indicates a selling price of $752.60 per bond sold. (Often, in the US, bond prices are quoted in points and thirty-seconds of a point, rather than in decimal form.) Some short-term bonds, such as the U.S. Treasury bill, are always issued at a discount, and pay par amount at maturity rather than paying coupons. This is called a discount bond. Although bonds are not necessarily issued at par (100% of face value, corresponding to a price of 100), their prices will move towards par as they approach maturity (if the market expects the maturity payment to be made in full and on time) as this is the price the issuer will pay to redeem the bond. This is referred to as " pull to par". At the time of issue of the bond, the coupon paid, and other conditions of the bond, will have been influenced by a variety of factors, such as current market interest rates, the length of the term and the creditworthiness of the issuer. These factors are likely to change over time, so the market price of a bond will vary after it is issued. (The position is a bit more complicated for inflation-linked bonds.) The interest payment ("coupon payment") divided by the current price of the bond is called the current yield (this is the nominal yield multiplied by the par value and divided by the price). There are other yield measures that exist such as the yield to first call, yield to worst, yield to first par call, yield to put, cash flow yield and yield to maturity. The relationship between yield and term to maturity (or alternatively between yield and the weighted mean term allowing for both interest and capital repayment) for otherwise identical bonds derives the
yield curve In finance, the yield curve is a graph which depicts how the yields on debt instruments - such as bonds - vary as a function of their years remaining to maturity. Typically, the graph's horizontal or x-axis is a time line of months or ye ...
, a graph plotting this relationship. If the bond includes embedded options, the valuation is more difficult and combines
option pricing In finance, a price (premium) is paid or received for purchasing or selling options. This article discusses the calculation of this premium in general. For further detail, see: for discussion of the mathematics; Financial engineering for the imple ...
with discounting. Depending on the type of option, the option price as calculated is either added to or subtracted from the price of the "straight" portion. See further under . This total is then the value of the bond. More sophisticated lattice- or simulation-based techniques may (also) be employed. Bond markets, unlike stock or share markets, sometimes do not have a centralized exchange or trading system. Rather, in most developed
bond market The bond market (also debt market or credit market) is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities, known as the secondary market. This is usually in the form of bonds, bu ...
s such as the U.S., Japan and western Europe, bonds trade in decentralized, dealer-based over-the-counter markets. In such a market, liquidity is provided by dealers and other market participants committing risk capital to trading activity. In the bond market, when an investor buys or sells a bond, the counterparty to the trade is almost always a bank or securities firm acting as a dealer. In some cases, when a dealer buys a bond from an investor, the dealer carries the bond "in inventory", i.e. holds it for their own account. The dealer is then subject to risks of price fluctuation. In other cases, the dealer immediately resells the bond to another investor. Bond markets can also differ from stock markets in that, in some markets, investors sometimes do not pay brokerage commissions to dealers with whom they buy or sell bonds. Rather, the dealers earn revenue by means of the spread, or difference, between the price at which the dealer buys a bond from one investor—the "bid" price—and the price at which he or she sells the same bond to another investor—the "ask" or "offer" price. The bid/offer spread represents the total
transaction cost In economics and related disciplines, a transaction cost is a cost in making any economic trade when participating in a market. Oliver E. Williamson defines transaction costs as the costs of running an economic system of companies, and unlike pro ...
associated with transferring a bond from one investor to another.


Investing in bonds

Bonds are bought and traded mostly by institutions like
central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a central b ...
s,
sovereign wealth fund A sovereign wealth fund (SWF), sovereign investment fund, or social wealth fund is a state-owned investment fund that invests in real and financial assets such as stocks, bonds, real estate, precious metals, or in alternative investments such as ...
s, pension funds,
insurance companies Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to hedge ...
,
hedge fund A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as s ...
s, and banks. Insurance companies and pension funds have liabilities which essentially include fixed amounts payable on predetermined dates. They buy the bonds to match their liabilities, and may be compelled by law to do this. Most individuals who want to own bonds do so through
bond fund A bond fund or debt fund is a fund that invests in bonds, or other debt securities. Bond funds can be contrasted with stock funds and money funds. Bond funds typically pay periodic dividends that include interest payments on the fund's underlyi ...
s. Still, in the U.S., nearly 10% of all bonds outstanding are held directly by households. The volatility of bonds (especially short and medium dated bonds) is lower than that of equities (stocks). Thus, bonds are generally viewed as safer investments than stocks, but this perception is only partially correct. Bonds do suffer from less day-to-day volatility than stocks, and bonds' interest payments are sometimes higher than the general level of dividend payments. Bonds are often liquid – it is often fairly easy for an institution to sell a large quantity of bonds without affecting the price much, which may be more difficult for equities – and the comparative certainty of a fixed interest payment twice a year and a fixed lump sum at maturity is attractive. Bondholders also enjoy a measure of legal protection: under the law of most countries, if a company goes
bankrupt Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debtor ...
, its bondholders will often receive some money back (the recovery amount), whereas the company's equity stock often ends up valueless. However, bonds can also be risky but less risky than stocks: * Fixed rate bonds are subject to '' interest rate risk'', meaning that their market prices will decrease in value when the generally prevailing interest rates rise. Since the payments are fixed, a decrease in the market price of the bond means an increase in its yield. When the market interest rate rises, the
market price A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the ...
of bonds will fall, reflecting investors' ability to get a higher interest rate on their money elsewhere—perhaps by purchasing a newly issued bond that already features the newly higher interest rate. This does not affect the interest payments to the bondholder, so long-term investors who want a specific amount at the maturity date do not need to worry about price swings in their bonds and do not suffer from interest rate risk. Bonds are also subject to various other risks such as call and prepayment risk,
credit risk A credit risk is risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased ...
, reinvestment risk, liquidity risk, event risk, exchange rate risk, volatility risk, inflation risk, sovereign risk and yield curve risk. Again, some of these will only affect certain classes of investors. Price changes in a bond will immediately affect
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV ...
s that hold these bonds. If the value of the bonds in their trading
portfolio Portfolio may refer to: Objects * Portfolio (briefcase), a type of briefcase Collections * Portfolio (finance), a collection of assets held by an institution or a private individual * Artist's portfolio, a sample of an artist's work or a c ...
falls, the value of the portfolio also falls. This can be damaging for professional investors such as banks, insurance companies, pension funds and asset managers (irrespective of whether the value is immediately " marked to market" or not). If there is any chance a holder of individual bonds may need to sell their bonds and "cash out", interest rate risk could become a real problem, conversely, bonds' market prices would increase if the prevailing interest rate were to drop, as it did from 2001 through 2003. One way to quantify the interest rate risk on a bond is in terms of its duration. Efforts to control this risk are called immunization or hedging. * Bond prices can become volatile depending on the credit rating of the issuer – for instance if the
credit rating agencies A credit rating agency (CRA, also called a ratings service) is a company that assigns credit ratings, which rate a debtor's ability to pay back debt by making timely principal and interest payments and the likelihood of default. An agency may ra ...
like Standard & Poor's and
Moody's Moody's Investors Service, often referred to as Moody's, is the bond credit rating business of Moody's Corporation, representing the company's traditional line of business and its historical name. Moody's Investors Service provides internationa ...
upgrade or downgrade the credit rating of the issuer. An unanticipated downgrade will cause the market price of the bond to fall. As with interest rate risk, this risk does not affect the bond's interest payments (provided the issuer does not actually default), but puts at risk the market price, which affects mutual funds holding these bonds, and holders of individual bonds who may have to sell them. * A company's bondholders may lose much or all their money if the company goes
bankrupt Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debtor ...
. Under the laws of many countries (including the United States and Canada), bondholders are in line to receive the proceeds of the sale of the assets of a liquidated company ahead of some other creditors. Bank lenders, deposit holders (in the case of a deposit taking institution such as a bank) and trade creditors may take precedence. There is no guarantee of how much money will remain to repay bondholders. As an example, after an accounting scandal and a
Chapter 11 Chapter 11 of the United States Bankruptcy Code (Title 11 of the United States Code) permits reorganization under the bankruptcy laws of the United States. Such reorganization, known as Chapter 11 bankruptcy, is available to every business, wheth ...
bankruptcy at the giant telecommunications company
Worldcom MCI, Inc. (subsequently Worldcom and MCI WorldCom) was a telecommunications company. For a time, it was the second largest long-distance telephone company in the United States, after AT&T. Worldcom grew largely by acquiring other telecommunic ...
, in 2004 its bondholders ended up being paid 35.7 cents on the dollar. In a bankruptcy involving reorganization or recapitalization, as opposed to liquidation, bondholders may end up having the value of their bonds reduced, often through an exchange for a smaller number of newly issued bonds. * Some bonds are callable, meaning that even though the company has agreed to make payments plus interest towards the debt for a certain period of time, the company can choose to pay off the bond early. This creates reinvestment risk, meaning the investor is forced to find a new place for their money, and the investor might not be able to find as good a deal, especially because this usually happens when interest rates are falling.


Bond indices

A number of bond indices exist for the purposes of managing portfolios and measuring performance, similar to the S&P 500 or Russell Indexes for stocks. The most common American benchmarks are the Bloomberg Barclays US Aggregate (ex Lehman Aggregate), Citigroup BIG and Merrill Lynch Domestic Master. Most indices are parts of families of broader indices that can be used to measure global bond portfolios, or may be further subdivided by maturity or sector for managing specialized portfolios.


See also

* Bond credit rating *
Collective action clause A collective action clause (CAC) allows a supermajority of bondholders to agree to a debt restructuring that is legally binding on all holders of the bond, including those who vote against the restructuring. Bondholders generally opposed such cla ...
*
Debenture In corporate finance, a debenture is a medium- to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term "debenture" originally referred to a document that either creates a debt or acknowle ...
*
Deferred financing costs Deferred financing costs or debt issuance costs is an accounting concept meaning costs associated with issuing debt (loans and bonds), such as various fees and commissions paid to investment banks, law firms, auditors, regulators, and so on. Since t ...
* GDP-linked bond *
Government bond A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments'','' and to repay the face value on the maturity dat ...
/
Sovereign bonds A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments'','' and to repay the face value on the maturity date ...
*
Immunization (finance) In finance, interest rate immunization is a portfolio management strategy designed to take advantage of the offsetting effects of interest rate risk and reinvestment risk. In theory, immunization can be used to ensure that the value of a portfo ...
* Promissory note * Short-rate model * Penal bond * Structured note Market specific *
Brady Bonds Brady bonds are dollar-denominated bonds, issued mostly by Latin American countries in the late 1980s. The bonds were named after U.S. Treasury Secretary Nicholas Brady, who proposed a novel debt-reduction agreement for developing countries. ...
* Build America Bonds * Eurobond General * Fixed income *
List of accounting topics This page is an index of accounting topics. {{AlphanumericTOC, align=center, nobreak=, numbers=, references=, externallinks=, top=} A Accounting ethics - Accounting information system - Accounting research - Activity-Based Costing ...
*
List of economics topics The following outline is provided as an overview of and topical guide to economics: Economics – analyzes the production, distribution, and consumption of goods and services. It aims to explain how economies work and how economic agen ...
*
List of finance topics The following outline is provided as an overview of and topical guide to finance: Finance – addresses the ways in which individuals and organizations raise and allocate monetary resources over time, taking into account the risks entailed ...


References


External links

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Bonds vs Stocks Which is Better?
An ultimate judgment of which better profitable bonds or stocks. {{DEFAULTSORT:Bond (Finance)