Bonds are a unique instrument of finance, and have their own individual definitions that an investor should be aware of. Three common terms that are used in bond market analysis are par values, maturity dates, and coupon rates. We will define each of these and explain their uses.
Par Values (No, it’s not golf).
Par values in bond markets refers to the face value. Easy right? Not really, because we now have to define face value. All bonds are purchased for a set period, and when the bond matures (maturity is explained later in this article) the value of the bond is the face value. A thousand dollar bond has a face value or par value of one thousand dollars.
Sadly, there is no extreme couponing involved with the bond market. Coupons are another way of saying interest rate. A bond coupon determines the amount of interest that is paid at the scheduled installments. Bonds can be paid monthly, quarterly, semi annually and annually, though most pay every six months. By way of example, a bond with a five thousand dollar par value, with a ten percent coupon, paid annually, would pay five hundred dollars per year.
The coupon rate is set at the time of issue so it is determined by a number of factors including the comparable coupon value of similar bonds and the credit rating of the issuer. Government bonds and municipal bonds tend to have a low coupon rate because of the stability of these institutions, whereas corporate bonds offer higher rates depending on the credit ranking and stability of the company. The formula generally translates to a higher coupon rate for a lower credit rating.
Much like coming into adulthood at 18 years, a bond maturity date is the pre-defined date at which the principal bond investment is paid back to the investor. So if you purchased a one thousand dollar bond, with a 5 year maturity, at the end of five years you would get your thousand dollars back.
Zero Coupon Bonds
One exception to these calculations is the Zero Coupon Bond instrument. This type of bond offers no coupon, but can be purchased at a very deep discount. It would be like a $5,000 bond trading at $4000. When the bond matures, the investor makes a $1,000 profit.
These are the basic factors an investor should know to determine their return on investment when purchasing bonds.