Corporate bonds revealed: How the pricing works
Corporate bonds provide companies a way to borrow money from investors. Companies do this by issuing bonds that can be traded on the stock exchange. But before you can even think about investing in bonds, you need to understand the prices. Read on to find out how the pricing works with corporate bonds...
Before a corporate bond
begins trading on the stock exchange for the first time, it usually has a starting value of R1,000, Phil Oakley in MoneyWeek
This starting value is known as its ‘par’ value. When a bond has a price above R1,000, it is trading ‘above par’. A price of less than R1,000 is referred to as ‘below par’.
Bond prices move around for lots of different reasons, just like share prices also move. But when you are buying a bond you need to be aware of how much you will actually pay for it.
For example, a company wants to borrow R100 million. So it divides this into individual bonds of R1,000 each and pays a 6% interest rate.
With bonds you need to look at the interest
The 6% bond starts trading on 1 January at R1,000. It pays interest (known as a coupon) of R30 twice a year: Once at the end of June, and once at the end of December. At the end of March, you decide to buy the bond.
You have a look on your broker’s website and see them quoting a price of R1,000. But when you buy the bond you find out that you have paid R1,015. Why is this?
Well, it’s due to what’s known as accrued interest. If you buy the bond between coupon payment dates, the seller of the bond is entitled to his share of the interest accrued over the period.
Because March is halfway through the six-month payment period, the seller would be entitled to R15 of interest (R30 x 3/6). So the R1,000 quoted on the broker’s website is the clean price. The R1,015 that you actually end up paying is known as the dirty price. This is made up of the clean price plus the amount of accrued interest.
So there you have it, how the pricing works with corporate bonds.