This is a list of common terms used in regards to bonds.
- Basis point
- Brokers
- Callable bond
- Coupon
- Credit risk
- Current yield
- Dealers
- Debentures
- Derivative
- Discount bond
- Duration
- Face value
- Inflation-indexed bonds
- Interest rate risk
- Junk bond
- Ladder
- Par
- Premium
- Principal
- Savings bonds
- Strips
- Treasurys
- Treasury Bills
- Treasury Bonds
- Treasury Notes
- Yield
- Yield curve
- Yield to call
- Yield to maturity
- Zeros
Basis point - Just one hundredth of one percentage point or 0.01%. Basis points make for a handy way to state small differences in yield. For example, it's much easier to say one bond yields 10 basis points more than another than it is to say it yields one-tenth of one percentage point more.
Brokers - A bond broker acts as your agent, calling around to different bond dealers to find the best prices for the bonds you want. Brokers may charge a fee for their service or simply make money by increasing the markup, or the spread between the purchase and sale price of a bond.
Callable bond - A bond which the issuer can decide to redeem before its stated maturity date. A call date and a call price are always given. You face a risk with a callable bond that it will be redeemed if its stated coupon is higher than prevailing rates at the time of its call date. If that happens, you won't be able to reinvest your capital in a comparable bond at as high a yield.
Coupon - The stated interest rate on a bond when it's issued. A $1,000 bond with a coupon of 6% will pay you $60 a year.
Credit risk - The danger that a bond issuer's ability to repay what it owes will deteriorate. Usually, that prompts bond rating firms to downgrade the company or municipality that issued your bond. And that, in turn, immediately sends the yield of the bond higher -- since investors will demand more in order to justify the higher risk -- and drive the price of the bond lower. Barring World War III or worse, Treasurys do not carry this risk since Uncle Sam is viewed as the world's most creditworthy borrower.
Current yield - You might think the current yield would be the same as the coupon rate on a bond. But, unless you're buying a new issue of a bond trading at par, it's not. Unlike the coupon rate, which doesn't change, the current yield of a bond fluctuates with a bond's price on the secondary market. To get the current yield, divide the coupon by the bond's current market price. For example, a bond with a $1,000 face value and a coupon of 6% purchased at $900 has a current yield of 6.7% (60 / 900). When the current yield of a bond rises, its market price declines. Conversely, when the current yield declines, the price of the bond rises.
Dealers - Dealers maintain their own inventory of bonds and make trades with either the general public or brokers. Dealers make money off the difference between the bid and ask price of a bond. If your broker offers to act as a dealer, that means he can sell you bonds from his own inventory. This is usually a better deal since it removes a layer of commissions that will be added if your broker has to go to another dealer to find you a particular bond.
Debentures - A common kind of corporate bond, often issued by a firm during restructuring. Debentures are backed only by the credit quality or essentially the good name of the issuer. Since there is no collateral, these bonds may carry a higher risk, and therefore a higher rate of return, when compared to an asset-backed bond. However, debentures of solid companies may be very highly rated.
Derivative - Any kind of investment whose value is derived from or linked to an underlying stock, bond, currency or mortgage. This could include futures, options, or more esoteric fixed-income investments with acronyms like TIGRs or CMOs that you should best stay away from.
Discount bond - One that sells at a current market price that is less than its face value. Bonds sell at a discount when the coupon on the bond is lower than prevailing rates. For example, you might have to pay only $812 for a bond with a 6.5% coupon if new issues yielding 8% are available for $1,000.
Duration - A way to measure part of the risk in a bond or bond fund. Duration tells you how long it will take to recoup your principal. It's a complicated calculation, so you'll have to get the number from your fund company or bond dealer, but it makes for a handy way to judge interest rate risk. If a bond or a bond fund has a duration of seven years, a 1% drop in interest rates will raise its value by 7%, while a 1% rise in interest rates will lower its price by 7%.
Face value - Just like it sounds: The value a bond has printed on its face, usually $1,000. Also known as par value, it represents the amount of principal you are owed at maturity. The bond's actual market value may be higher or lower.
Inflation-indexed bonds - These Treasurys are designed to keep pace with inflation. The principal is adjusted to match changes in the consumer price index, while the interest rate remains fixed. In this way, inflation can not erode the value of your principal. New in 1997, they are officially known as Treasury Inflation Protection Securities or TIPS.
Interest rate risk - This is the danger that prevailing interest rates will rise significantly higher than the rate paid on bonds you are holding. This drives down the price of your bonds, so if you sell you'll lose money. This is a serious risk for anyone investing in long-term bonds, including Treasurys, because the longer the maturity, the higher the interest rate risk (see duration).
Junk bond - These are the lowest quality bonds. Since they are riskier, they yield more. Other, more flattering names for them are "high yield" or "non-investment-grade" bonds. See credit risk.
Ladder - A portfolio strategy where fixed-income investors stagger the maturities of their bond holdings in order to provide regular cash flow as the bonds come due and smooth out the effects of interest rate fluctuations. For those with enough assets allocated to bonds, we recommend putting equal amounts of money into Treasurys due to mature in one, three, five, seven, and nine year periods. That gives your portfolio an average maturity of five years. As the principal comes due every two years, you can reinvest that amount in bonds due to mature in 10 years. That way, you keep your portfolio's average maturity at five years or so.
Par - A bond that is trading at par is selling for the same amount as its face value, or par value.
Premium - A premium bond sells at a current market price that is more than its face value. Bonds sell at a premium when the coupon on the bond is higher than prevailing rates. For example, you might have to pay $1090 for a bond with a 6% coupon if new issues yielding 5.5% are available for $1,000.
Principal - The face value or par value of a bond.
Savings bonds - A unique kind of bond that can't be traded and, similar to zero-coupon bonds, is sold at a discount (with Series EE it's sold at half of par), and is worth the face amount at maturity. They are exempt from state and local taxes and you can defer paying federal taxes until maturity. They can be purchased for as little as $25 or up to $5,000 with a maximum of $15,000 each year. The cost and the maturity depend on the series (E, EE and HH) and the interest rate being paid. They can be bought or redeemed (after six months) at your local bank, the Federal Reserve or the Bureau of Public Debt. Call (800) US-BONDS or go to United States Savings Bonds to get more information and current rates.
Strips - See zero-coupon bond. Strips is the term traders use for Treasury zeros. It stands for Separate Trading of Registered Interest and Principal of Securities, as well as the fact that the coupon payment is effectively "stripped" from the bond principal.
Treasurys: These bonds are issued by the U.S. Department of Treasury, so interest and principal is guaranteed by Uncle Sam. Taxable at the federal level, they are exempt from state and local taxes.
Treasury Bills (T-Bills) - Mature in one year or less. T-Bills are purchased at a discount to the full face value which is payable when they mature. T Bills are issued for a minimum of $10,000 with $1,000 increments thereafter.
Treasury Bonds (T Bonds) - Mature in 10 to 30 years. Interest is paid semiannually and they can be purchased in minimum denominations of $1,000 or multiples thereof. The 30-year, or "bellwether" bond, is the key measure of interest rates.
Treasury Notes (T-Notes) - Mature in two to 10 years. Interest is paid twice a year and they can be purchased in denominations of $1,000.
Yield - Stated simply, the yield on a bond is the interest you actually earn on your investment. If you buy a new issue, your yield is the same as the interest rate, but if you buy on the secondary market, your yield may be higher or lower. When the yield of a bond goes up, it's price has fallen. Conversely, if a bond's yield falls, its market value has risen.
Yield curve - This is a graph showing the yields for different bond maturities. It can be used, not only to show where the best values in bonds are, but also as an economic indicator. To learn more, check out our Living Yield Curve.
Yield to call - Yield to call is the yield on the bond to the call date at the call price.
Yield to maturity - Yield to maturity is similar to current yield, but it also takes into account any gain or loss of principal at maturity. For example, if a $1,000 par bond was bought at a discount of $900, at maturity there would be a $100 gain. Likewise, if a $1,000 par bond is purchased for $1090, there will be a $90 loss in principal at maturity. Yield to maturity is a precise measure that allows you to compare bonds with different maturities that sell for more or less than par. The trouble is, it is a complex calculation that isn't printed in the paper, so you'll have to get it from your broker or bond dealer.
Zeros - Zero-coupon bonds, (the Treasury's version of zeros are known as Strips), do not pay out interest annually. Rather, they are purchased at a discount and, at maturity, all compound interest is paid and the bondholder collects the face value of the bond. However, since interest is technically earned and compounded semiannually, holders of zeros are obliged to pay taxes each year on the interest as it accrues. Many investors like to time the maturity of their zero coupon bonds to coincide with certain anticipated expenses, such as college tuition.
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