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Major elements that must be in a bond issue

Bonds come in many varieties, however, some characteristics are unique to all of them, and should be understood by any potential bond investor.

  1. Government bonds can be short term a few months to many years 10 or 30 years.
  2. In many cases, the objective of issuing a bond is to raise funds at the cheapest possible cost.
  3. This is particularly suitable if this currency is one in which there is a liquid corporate bond market for instance, the US Dollar or the Euro or if the main intention is simply to tap potential investors in the home market.
  4. For this reason, under a rising interest rate environment, the issuer of the original bond would find it difficult to find a buyer willing to pay par value for their bond, because a buyer could purchase a newly issued bond in the market that is paying a higher coupon amount. If the rating goes down, it will drive their bond prices lower.
  5. Call Risk for Bond Investors Another risk is that a bond will be called by its issuer.

This represents the amount of principal that a bondholder will receive at maturity, and is also the value that that a bond is issued for at the time that a company or government first sells them. Government bonds are often sold with higher face values, some of which can be as high as a hundred thousand or even a million dollars. The face value of a bond should not be confused with the price of a bond observed in the market — the face value is always a given amount, while the price of a bond will fluctuate over time.

We will discuss what influences bond prices in the next section of this tutorial.

Reinvestment Risk for Bond Investors

When the observed market price of a bond is lower than the stated face value, it is said to be trading at a discountand when the market price is higher than par it trades at a premium.

Interest payments on corporate bonds are typically paid semi-annually but may also be paid annually or quarterly. Some bonds do not pay a coupon at all zero-coupon bondsbut are instead sold at an initial discount to be repaid at the full face value at maturity, which has the same net effect as paying interest on a bond sold at face value.

  • Interest rates In general, when interest rates rise, bondBond A kind of loan you make to the government or a company;
  • This will be your actual return if you hold the bonds to maturity or until the issuer redeems the bonds;
  • This will be your actual return if you hold the bonds to maturity or until the issuer redeems the bonds;
  • This is the date when the issuer redeems the bonds and pays you the face value of the bonds;
  • Dealers Communication with potential and actual investors is one of the main roles of the panel of dealers.

If the interest rate paid on a bond remains the same for the life of the security it is a fixed ratewhile if it floats and changes over time it is referred to as adjustable or variable rate. The yield of a bond is determined by a number of factors.

First, the prevailing interest rate environment, second inflation expectations, and third the chances of being repaid or not. The greater the risk of not being repaid, the higher the yield on the bond. A bond with a shorter maturity is more predicable, therefore than a bond with a long maturity — and therefore a bond with a longer maturity will carry a higher interest rate.

2. Inflation

A company on an insecure financial footing will also carry a higher interest rate on its bonds since it may be more likely to default than a solid, blue chip company. Maturities for corporate bonds are typically in the range of one to five years, with some bonds maturing in 10 or even 30 years.

Bond Basics: Characteristics

Occasionally, a company will issue a so-called century bond that matures in 100 years. Government bonds can be short term a few months to many years 10 or 30 years.

What are the risks of investing in a bond?

Issuer The type and quality of the bond issuer is also an important characteristic of a bond, as the issuer's stability is your main assurance of getting paid back in full. For example, the U.

  1. In practice, some compromise may be necessary.
  2. Issuers should take advice from their dealers on how best to manage the secondary market. It is important for the company seeking to raise funds from a bond issue to tailor the offering to suit both their own requirements and those of their potential investors.
  3. Initially, European bond investors were only prepared to purchase bonds issued by the most creditworthy corporate names. In both cases, the decision will expose the company to an interest rate risk which will need to be managed.
  4. Yield is the number that accounts for these factors.
  5. Issuing a bond will also affect the longer term funding strategy for the company.

The reason behind this is that a government will always be able to bring in future revenue to pay its debts through taxation. A company, on the other hand, must continue to make profits, which are far from guaranteed.

Bond issuance – the key questions

For corporate bonds, there is a fairly standardized bond rating system, based on the analysis of credit rating agencies, to help investors determine a company's credit or default risk. Think of a bond rating as the report card for a company's credit rating.

Blue-chip firms, which are large, financially secure companies issue bonds that are safer investments, and have a high rating, while risky companies have a low rating. The chart below illustrates the different bond rating scales from the major rating agencies in the U.

Moody's, Standard and Poor's and Fitch Ratings.