Important terms an investor should know if you have bonds in your portfolio
What comes to your mind when you think of investing/ Equity, debt, bonds, real estate, gold, cryptocurrency, etc. Each one of us invests in an instrument according to our goals and risk appetite. Risk & returns are inversely proportionate to each other. Higher the risk, the higher the return & vice-versa. People typically opt for equity for high returns on the investment & bonds are considered as a safe haven if an investor needs a fixed amount of regular interest payments. It is essential for an investor to be well-informed about the instrument in which they are investing. We will be talking about bonds and demystifying the jargons associated with it.
Bonds are one of the safest options for investment provided that an investor must be well equipped with the financial terms associated with it. People usually find finance-related terms a bit more difficult to understand. By going through this article, you can easily be well-equipped with the financial jargons associated with the bond market. Our vision is to simplify finance for everyone to get a wholesome understanding of this vast finance world.
We'll make you well equipped with all the terms of bonds, so you can seamlessly make a decision to invest.
Let’s get started with the Terminology of Bonds.
Par Value: The most important element of bonds is par value, which is also known as the face value. The par value is the sum amount of money or the principal amount that the issuers of bonds promise to pay back to the bondholders at specified maturity date. The par value of a bond in the Indian market can typically range from as low as Rs. 1000 to as high as Rs. 1 crore.
Discount: The bond may not be significantly trading at its par value. The rate of a bond fluctuates according to the interest rates in the economy. If the level of interest rate is high, the bonds will be trading at a discount. For example, a bond with a face value of Rs. 10,000 that is currently trading at Rs. 9000 is considered a discount bond.
Premium: Premium bonds contradicts discount bonds. The rate of a bond fluctuates according to the interest rates in the economy. f the level of interest rate is low, the bonds will be trading at a premium. For example, a bond with a face value of Rs. 10,000 that is currently trading at Rs. 11,000 is considered as a bond trading at a premium.
Market Value: Market value denotes the current prices of bonds at which they’re actually being bought & sold in the market. The market value is derived after the bond has been issued at the par or face value to its bondholders. The market value of a bond can be fluctuating as the bond can be trading either at its discount or premium price. The value of a bond depends upon various other factors such as level of interest rates, economic condition, industry condition of the bond issuer, etc.
Coupon rate: A coupon rate is a rate that the bond issuer pays the bondholder on an annual basis & it is based on the face value of the bond. This amount is typically paid as per the predetermined routine which can be annual, monthly, quarterly, or bi-annually until the date of maturity arrives. For example, If the bond pays Rs. 300 annually, it has a coupon rate of 3% (Rs. 30 divided by Rs. 10,000).
Bond issuer: A bond issuer is a body of different institutions, also called borrower who sell bonds with the assurance to pay back the principal amount along with the regular interest payments on the date of maturity. There are various types of bond issuers such as government, firms, supernational entities, municipalities, special projects, etc.
Maturity: The maturity of a bond refers to a time period in which the bond issuer or the borrower needs to pay back the par value of the bond to the bondholder. On the date of maturity, the company’s bond obligation comes to an end. Maturity can fall into these three categories namely – Short, medium, and long term.
Short Term – Bonds that are a part of this category tend to mature within one to three years.
Medium-Term - Bonds that are a part of this category tend to mature after 10 years.
Long Term - Bonds that are a part of this category tend to mature over longer time periods.
8. Yield to maturity: Yield to maturity refers to the rate of return (in percentage) that an investor gets by purchasing a bond today & holding it until the maturity of the bond. There are various online calculators available if you want to know the yield to maturity of any bond. YTM is a mixture of coupon or the interest paid by the bond, price paid by the investor, and the discount or premium price paid by the investor which they will be getting back on the date of maturity.
Ratings: Ratings are an important part of identifying if the bonds are safe to invest in or not. To get a detailed analysis of ratings of bonds, you can refer to our article on Green Bonds where we have explained ratings in detail.
These were some important terms that an investor should know if they have bonds in their portfolio. Share it with your friends, family, and colleagues if they’re also thinking to invest in bonds, so they can have a clear knowledge of what they are investing in.