What is a Bond
A bond is a debt-instrument or security that is used to raise capital in the form of a loan to the bond issuer. In return, the bond issuer provides a promise to the investor or bondholder for the return of principal and the payment of some form of interest in the future.
Bonds can be in the form of fixed-income, variable-income or sold at a discount with the face value paid at maturity.
Components of a Bond
- Face Value
The face value is the par value of a bond that is stated by the bond issuer, which is also the amount paid to the bondholder at maturity for the repayment of principal.
- Coupon Rate
The coupon rate is the annual interest rate that is paid on the face value of the bond, generally on a semi-annual basis.
- Maturity Date
The maturity date is the date of which the face value of the bond and any final interest is paid. At maturity, the bond issuer has fulfilled the debt-obligation to the bondholders.
- Bond Issuer
The bond issuer is the entity who is the borrower of the money and who is responsible for the repayment. The issuer may be a government, municipality, corporation or supranational.
- Credit Quality
The credit quality of an issue indicates the creditworthiness or probability that the bond issuer will pay the promised amounts to the bondholders on the due dates.
- Tax Status
The tax status of a bond can vary based on the type of bond and the location of the investor.
- Bond Indenture
A bond indenture is a legally binding agreement or contract between a bond issuer and the bondholder that covers all the terms, conditions and provisions related to the bond and how the bond is managed. Some of the items that could be found in a bond indenture include a covenant, call provision, put provision or sinking fund. A bond indenture is also known as a bond resolution.
A bond covenant, which is part of the indenture, details what activities must be completed by the bond issuer and what activities are forbidden. Bond covenants are designed to protect the interests of both parties.
- Call Provision
A callable bond is where the issuer has the right to redeem the bond (call the bond away) from the investors on specified call dates, prior to maturity, for a price determined at the time that the bond is issued. This amount will typically be at a premium to the face value of the bond.
- Put Provision
A puttable bond is where the investor has the right to sell the bond back to the issuer on specified put dates, prior to maturity, at a price that is specified at the time that the bond is issued.
- Sinking Fund
A sinking fund is an account that is set up by the bond issuer to pay off a bond at maturity or to buy bonds back in the open market. Callable bonds that have a sinking fund may increase the likelihood a bond issuer will buy back the bonds prior to maturity if it is to their advantage.
Registered Bond or Bearer Bond
A registered bond will record and maintain the bondholder's identifying information with the issuing party to ensure bond payments of principal and interest go to the registered party. The registered information can be physically printed on the bond certificate or it can also be electronically registered, where the information is part of a database.
A bearer bond does not record any owner information. Without any registered information of ownership, the principal and interest payments of a bearer bond will go to the holder of the certificate and the interest coupons. While less secure as compared to a registered bond, a bearer bond has been favored by money launderers, tax evaders and others seeking maximum privacy in their business dealings.
Fixed-Rate, Floating-Rate or Zero-Coupon
A fixed-rate bond will have an interest rate or coupon rate that remains constant throughout the life of the bond. A variation of a fixed-rate bond is a stepped-coupon bond, whose coupon rate will have pre-set rate increases during the life of the bond.
A floating-rate bond will have an interest rate or coupon rate that can change during the life of the bond. The variable-rate coupon is linked to a reference rate of interest, such as LIBOR or Euribor, that is used to recalculate the interest rate periodically, which is typically monthly or quarterly.
A zero-coupon bond does not pay a regular interest rate. The bond is issued at a discount to par value. During the life of a zero-coupon bond, the value of the bond will fluctuate based upon the current interest rate environment but at maturity, the face value of the bond will be paid in full.
Top 8 Risks to Bonds
- Market Risk
The risk that bond values decrease due to adverse market conditions or unexpected events. Market risk is also known as systemic risk.
- Credit Risk
The risk that a bond issuer may fail to make timely interest or principal payments. Credit risk is also known as default risk.
- Interest Rate Risk
The risk that a change in interest rates can affect the value of a bond. If sold before maturity, a bond may be worth more or less than the face value, depending on the direction of the interest rate move.
- Inflation Risk
The risk that an increase in inflation will reduce the purchasing power of the bondholder that is receiving a fixed-rate of interest on their bond.
- Liquidity Risk
The risk that a bondholder will not be able to find a market for a bond prior to maturity if they want to sell the bond.
- Call Risk
The risk that a bond issuer will redeem or retire a bond prior to the maturity date, which may be an action a bond issuer could do if interest rates decline.
- Reinvestment Risk
The risk that interest and principal payments may not be able to invest at the rate of return the bond pays.
- Downgrade Risk
The risk that a major credit agency downgrades the creditworthiness of a bond issuer prior to the maturity date.
Most Common Types of Bonds
- Sovereign Bonds
A sovereign bond is a debt-obligation that is issued by a national government to raise money for financing government programs, to pay debt, to pay interest on current debt and to handle any other government spending needs.
- U.S. Government Bonds
A U.S. government bond is issued by the U.S. Treasury and backed by the full faith and credit of the U.S. government. Types of U.S. government bonds include T-Bonds, T-Notes, T-Bills and TIPS.
- Government Agency Bonds
A government agency bond is an indirect debt-obligation issued by a government-sponsored entity or by a federal government department other than the U.S. Treasury. A government agency bond is also known as agency debt. There are two types of government agency bonds, which are federal government agency bonds and government-sponsored enterprise (GSE) bonds.
- Corporate Bonds
A corporate bond is a debt-obligation issued by a corporation to raise funds for ongoing operations, business expansion, merger and acquisition, or any other purpose to support the corporation. Corporate bonds are divided into two main categories, which are investment-grade and high-yield.
- Municipal Bonds
A municipal bond is issued by a U.S. state, county, city, town, village or local authority to raise funds for general use or specific public works projects. The most common types of municipal bonds are general obligation bonds, revenue bonds and conduit bonds.
- Supranational Bonds
A supranational bond is issued by a global entity that is not based in a specific nation. More specifically, a supranational has members that exist in multiple countries. Examples of supranational entities that issue bonds are the IMF, World Bank or the European Investment Bank.
- Foreign Bonds
A foreign bond is a bond that is issued in a domestic market, using the regulations and currency of the domestic country but issued by a non-resident or foreign entity. There are many different types of foreign bonds, many of which have interesting names related to their location or culture. Here is a list of foreign bonds.
A Eurobond is a bond that is denominated in a currency other than the home currency of the country or capital market in which it is issued. Since a Eurobond is issued in an external currency, it is also known as an external bond or global bond.
- Eurodollar Bond
A Eurodollar bond is a US-dollar denominated bond that is issued by a non-US issuer outside of the US capital market and the issuer's home country. It is a type of US dollar-denominated Eurobond.
- Eurosterling Bond
A Eurosterling bond is a UK sterling-denominated bond that is issued outside of the UK capital market and the issuer’s home country. It is a type of UK sterling-denominated Eurobond.
- Euroyen Bond
A Euroyen bond is a Japanese yen-denominated bond that is issued by a non-Japanese issuer outside of the Japan capital market and the issuer’s home country. It is a type of Japanese yen-denominated Eurobond.
- Arirang Bond (South Korea)
An arirang bond is a Korean won-denominated bond that is issued by a non-Korean issuer in the South Korea capital market.
- Baklava Bond (Turkey)
A baklava bond is a Turkish lira-denominated bond that is issued by a non-Turkish issuer in the Turkey capital market.
- Bulldog Bond (UK)
A bulldog bond is a UK sterling-denominated bond that is issued by a non-British issuer in the UK capital market.
- Dim Sum Bond (Hong Kong)
A dim sum bond is a Chinese renminbi-denominated bond issued by a Chinese insurer in the Hong Kong capital market.
- Dragon Bond
A dragon bond is a US dollar-denominated bond that is issued in one of the “Dragon” economies of Asia, such as Hong Kong, Singapore and Taiwan.
- Formosa Bond (Taiwan)
A formosa bond is a non-New Taiwan dollar-denominated bond that is issued by a non-Taiwan issuer in the Taiwan capital market.
- Huaso Bond (Chile)
A huaso bond is a Chilean peso-denominated bond that is issued by a non-Chilean entity in the Chile capital market.
- Kangaroo Bond (Australia)
A kangaroo bond is an Australian dollar-denominated bond that is issued by a non-Australian issuer in the Australia capital market.
- Kimchi Bond (South Korea)
A kimchi bond is a non-Korean won-denominated bond that is issued by a non-Korean issuer in the South Korea capital market.
- Komodo Bond (Indonesia)
A komodo bond is an Indonesian rupiah-denominated bond that is issued outside of the Indonesia capital market for the purpose of funding infrastructure projects in Indonesia.
- Kungfu Bond (China)
A kungfu bond is a US dollar-denominated bond that is issued by a Chinese issuer outside of the China capital market.
- Lion City Bond (Singapore)
A lion city bond is a Chinese renminbi-denominated bond that is issued by a foreign issuer in the Singapore capital market.
- Maple Bond (Canada)
A maple bond is a Canadian dollar-denominated bond that is issued by a non-Canadian issuer in the Canada capital market.
- Masala Bond (India)
A masala bond is an Indian rupee-denominated bond that is issued by Indian issuers outside of the India capital market.
- Matador Bond (Spain)
A matador bond is a euro-denominated bond that is issued by a non-Spanish issuer in the Spain capital market.
- Matilda Bond (Australia)
A matilda bond is an Australian dollar-denominated bond that is issued by a non-Australian issuer in the Australia capital market.
- Matryoshka Bond (Russia)
A matryoshka bond is a Russian ruble-denominated bond that is issued by a non-Russian issuer in the Russia capital market.
- Panda Bond (China)
A panda bond is a Chinese renminbi-denominated bond that is issued by a non-Chinese issuer within the mainland China capital market.
- Rembrandt Bond (Netherlands)
A rembrandt bond is a euro-denominated bond that is issued by a non-Dutch issuer in the Netherlands market.
- Samurai Bond (Japan)
A samurai bond is a Japanese yen-denominated bond that is issued by a non-Japanese issuer in the Japan capital market.
- Schengen Bond (Luxembourg)
A schengen bond is a Chinese renminbi-denominated bond that is issued by a Chinese issuer in the Luxembourg capital market.
- Shibosai Bond (Japan)
A shibosai bond is a Japanese yen-denominated bond that is issued by a non-Japanese issuer in the private market.
- Shogun Bond (Japan)
A shogun bond is a non-Japanese yen-denominated bond that is issued by a non-Japanese issuer in the Japan capital market.
- Sushi Bond (Japan)
A sushi bond is a non-Japanese yen-denominated bond that is issued by a Japanese issuer outside of the Japan capital market for Japanese investors.
- Uridashi Bond (Japan)
An uridashi bond is generally a non-Japanese yen-denominated bond that is issued by a non-Japanese issuer for Japan retail investors. They are a secondary placement of bonds that have already been issued.
- Yankee Bond
A yankee bond is a US dollar-denominated bond that is issued by a non-US issuer in the US capital market.
- ABC Bond
- Aladdin Bond
- Angel Bond
- Blanket Bond
- Build America Bond (BAB)
- Bunny Bond
- Catastrophe Bond
- Climate Bond
- CoCo Bond
- Coronavirus Bond (China)
- Death Spiral Convertible Bond
- Dual Currency Bond
- Equity Bond
- Extendible Bond
- Fairway Bond
- Floating Rate Convertible Bond
- Floorless Convertible Bond
- Green Bond
- Inflation-Indexed Bond
- Limited-Tax Bond
- Methuselah Bond
- Moral Obligation Bond
- Moving Strike Convertible Bond
- Perpetual Bond
- Pot Bond
- Reverse Convertible Bond
- Self-Liquidating Bond
- Serial Bond
- Sinkable Bond
- Social Impact Bond
- Subordinated Bond
- Tuna Bond
- War Bond