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Your essential guide to understanding bonds

by , 04 February 2015

When you start delving into the world of bonds, one of the first things you may notice is that bonds come with their own ‘language'.

To gain a basic understanding of how bonds work, you need to get to grips with these terms.

So what do you need to know about bonds?

Read on to find out…


The fixed-income world of bonds


Around the world, governments and corporations issue bonds as a way to raise cash. Bonds are a way for governments and companies to raise cash without getting finance elsewhere.

This means when you buy a bond, you’re lending money to the issuer of the bond. And for lending this money, you’ll receive interest payments for the term of the bond. Once the bond matures, you’ll receive the initial amount of the bond back.

To really understand how bonds work, you need familiarise yourself with the terms used…


The basic terminology surrounding bonds


Coupon
The coupon is the interest rate you receive when you buy bonds. Usually you’ll receive this twice a year and it’s fixed for the life of the bond.

This means when you buy bonds, you know exactly how much interest you’re going to receive.

The coupon is also known as the interest income or the nominal yield.

Maturity
A bond’s maturity is the number of years before a bond expires. For example, retail savings bonds come with maturities ranging from two to five years.

The vast majority of bonds comes with a single maturity date. There are called term bonds.

Principal value
The principal value is the value of the loan on the date it was issued. This is also called the bond’s par value.

If you bought a bond on the day it was issued, this is the amount you’d pay for it. The value of bonds change through their life, so after the day of issue, the price is known as the current market price of the bond.

So there you have it, your essential guide to understanding bonds.

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Your essential guide to understanding bonds
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