How To Define 'Bond' And Other FAQS

As students of financial management courses in college, questions along the lines of "define bond" that then segued to related queries were relatively easy. Definitions were arguably easier than calculations of bond yields, prices and risks, among others.

Well, you may have forgotten a few things about bonds so this article will aim to refresh your memory. You will then be able to understand many of the more technical terms involved in bond trading and investing.

From the simple request to define bond comes a whole host of related questions. But let's take it one question at a time.

What is a bond?

It is a debt instrument issued by either a corporation or the government on the federal, state and local levels. The value of the bond stated on the certificate is known as the par or face value. The aims of bond issuance usually center on the capital requirements for current operations and future expansions like infrastructure projects.

What is a coupon rate?

Basically, this is the annual interest rate paid on the bonds. It is usually stated on the bond certificate with the interest amounts paid out to bondholders on a semi-annual basis.

What is the zero coupon rate?

You will not be paid an interest amount on the bond even after the maturity period has expired. Instead, you will purchase the bond at a discount and, thus, make a profit on the maturity period. For example, you will buy a $1,000 bond for $950 and then cash it in for its face value after one year - you have made a $50 profit.

What are the maturity period and the bond duration?

Any discussion related to the "define bond" request will be incomplete without mention of these two periods. The maturity period is the exact date on which the bond's principal along with any demandable interest amount must be repaid to the bondholder. The bond duration is different in that it is the average time required to collect all the due payments on the bond principal and interest. Take note that the bond duration can be longer than the maturity date.

What Are the Types of Bonds?

Of course, the "define bond" matter will not be complete either without mentioning the types of bonds available. There are many so we shall limit the brief discussion to just a few of the most common:

• Fixed rate bonds have constant interest rates throughout their lives.
• Floating rate bonds have variable interest rates that are linked to reference rates like the LIBOR.
• Inflation-linked bonds have their principal and interest payments linked to inflation rates.
• Unsubordinated bonds have higher priorities than subordinated bonds in case of liquidation by the issuer.
• Perpetual bonds have no maturity dates.
• Bearer bonds have no named holders while registered bonds have recorded ownership usually either by the issuer or by a transfer agent. The former can be traded like cash but have high risks for being stolen.
• Treasury bonds are issued by the federal government under the Department of Treasury while municipal bonds are issued by state and local governments ostensibly to fund infrastructure projects that may or may not be income-generating.

Indeed, when you are asked to define bond, you will encounter many more questions about the what, when, where, why and how of these debt instruments.