When an entity requires funds for operations, one of the ways it raises it is by issuing bonds to investors. In exchange for these funds, the entity pays interest to the investors. Bonds are debt instruments and are raised by companies as well as governments.
There are several types of bonds online such as government bonds, treasury bonds, corporate bonds, sovereign gold bonds, etc. These bonds are offered to investors in the primary market. It helps public and private organisations to draw sufficient corpus to support future business operations and advance infrastructural development. These bonds are then traded by investors in the secondary market.
Oftentimes, investors venturing out in the bond market wonder how to pick bonds as the terminologies associated with bond investments may seem complex. Here we are going to understand certain jargon that is used recurrently in bond investment and trading. Let’s get right to it:
- Bond issuer
The bond issuer is the entity – private company, public company, or government – issuing the bond with the certainty of recurring interest payments and return of principal sum at the time of maturity.
- Face value
In simple terms, the price at which the bond issuer issues each bond is known as the face value. The range of bonds online falls within Rs. 1,000 to Rs. 1 crore bracket.
- Market value
After the bond has been issued at face value, the current value at which it is traded is the market value of the bond. Trading of the bond is nothing but the buying and selling of bonds in the market. It can be either at a discount to the face value or may be trading at a premium rate.
Bondholders are to receive an amount of interest on an annual or semi-annual basis. This is called a coupon payment. A coupon payment may be computed using the following formula:
Face value of bond x Coupon rate of the bond in %
- Payment frequency
The interest on bonds is generally paid as per a pre-defined schedule, called the payment frequency, which can be annually, semi-annually, quarterly, or monthly.
The maturity date is the pre-defined date at which the bondholder is eligible to receive the principal amount of the bond, after which the interest payments are no longer made to the bondholder.
- Yield to Maturity (YTM)
Yield to Maturity is the estimated effective returns an investor can expect for holding the bonds until the maturity period. It is expressed as a percentage.
Ratings are purely performance-based and are a mark of the creditworthiness of the bond. The range of ratings is AAA to AA to A and can be further down. Bonds with AAA ratings are considered to be the best and safest investments. Factors considered for giving these ratings are the issuer’s ability to pay back the principal on maturity and the overall financial strength of the company.
Once you’ve understood these basic terms, you can consider investing in bonds confidently. When it comes to returns, bond investment guarantees it in the form of the interest that is to be paid by the issuer. Bond investment also allows investors to add a layer of stability and diversification to their portfolio.
You can consult a financial expert to determine the right investing strategy for you based on your financial goals, risk tolerance, and current investments.