A bond is an acknowledgement of debt issued by a borrower to a lender.
Bonds are fixed income security i.e the bond holder is entitled to a fixed rate of interest (known as the coupon rate) on the amount of debt acknowledged on the face of the bond (the principal amount).
Bonds are typically issued for a fixed duration post which they are either redeemed (i.e repaid) or converted into another security like equity share of the issuer.
The terms related to the issue of a bond also state the frequency of payment of interest on the principal amount.
Bonds are typically issued by corporations and governments.
Bonds are Marketable Securities
Bonds are marketable securities. This means that they can be bought and sold in the open markets.
One would imagine that a bond would be bought and sold at its face value (principal value).
However, this most often is not the case. The market price of a bond fluctuates with changes in the interest rate environment.
If the prevailing interest rate is higher than the coupon rate of a bond, it would trade lower than its face value. Similarly, if the prevailing interest rate is lower than the coupon rate on the bond, the same will trade higher than its face value.
You can read my article on how interest rate affects bond price, to understand this better.
Interest Rate Vs Yield.
Interest rate is the rate of interest earned on the principal amount of the bond.
For example, if a 10 year bond with the face value of INR 1,00,000 has a coupon rate of 10% payable annually, the holder of the bond would receive INR 10,000 as Interest Income annualy.
Yield is a term to define the actual return on an investment over a period of time.
Continuing with the same example, if an investor has purchased the same bond from the open market at the price of INR 1,10,000, he will still earn INR 10,000 as annual interest (10% on the principal/face value of INR 1,00,000).
However his actual return on his investment i.e yield would be different than the coupon rate of 10%.
His annual yield would be calculated as:
Annual Interest Income divided by his Actual Investment
= 10,000/1,10,000 or 9% p.a
Note that the term dividend is not limited to bonds alone.
For example, we can also calculate dividend yield on the equity shares of companies which pay dividend.
Here, the dividend yield would be the annual divided paid divided by the market price of the share.
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