Below is a list of common terms you can use when talking about investing and your investments.
So, if you hear someone say that a bond has a price of 80 points, you now know that this means the bond is selling at 80% of its original face value.
An evaluation or grade on the possibility of default by a bond issuer. Ratings range from AAA (default is highly unlikely) to D (defaulted or in bankruptcy), and are assigned by credit rating agencies, such as Moody`s, S&P, and Fitch Investors Service.
The firm often has stockholders and bondholders. In a liquidation, the bondholders have first priority. (Link to discussion of repayment in stocks)
A bond that is redeemable by the issuer before the scheduled maturity date, usually under specific conditions and prices. Typically, bonds are called when interest rates fall so drastically that the issuer can save money by issuing new bonds at the lower rates.
The interest payment made to a bondholder. A “zero” coupon bond has no monthly interest payment. Instead, the principle and the total interest accumulated over the life of the bond are paid at the maturity date. Zero coupon bonds are purchased at a discount to the face value of the bond.
A method of calculating the rate of return on a bond, without considering the premium or discount of the purchase price. It is calculated by dividing the coupon rate by the market price.
The act of failing to repay the principal or make timely interest payments on a bond.
A method of calculating bond yield, based on the annual percentage rate with reinvestment of the interest payments.
A method of calculating bond yield, based on the annual percentage rate without reinvestment of interest payments.
An entity that creates (issues) a financial asset.
Bonds that are considered non-investment grade, due to a high risk of default. Junk bonds usually have a rating of BB or lower. In order to compensate for the high likelihood of default, junk bonds have higher yields than other investment grade bonds.
The date that the principle of a bond is due or payable.
If you choose to sell prior to maturity, there is a risk that you will create a loss of principle due to the change in interest rate (from the time at which you purchased it), lack of buyers (i.e. liquidity), and transaction costs.
The actual dollar amount printed on the bond. Also called the “face value”.
Premium / Discount
A bond is selling at a premium when the bond’s market price is higher than its face value. A bond is selling at a discount when the bond’s market price is lower than its face value.
The amount of money that is being borrowed.
The yield curve is a term that is discussed in financial newscasts as though it were common knowledge. We’re here to make the latter part of that statement true.
The yield curve is a graphical representation o the relationship between interest rates and the due date (maturity) of a particular type of bond (usually treasury bonds).
There are three common types of yield curve “states”:
Yield to Call (YTC)
The rate of return (percentage) paid if the investor buys and holds it until the call date. The YTC is valid only when a security is called prior to maturity.
Generally, bonds are callable for several years and at a slight premium. The calculation of YTC is based on the coupon rate, length of time to call, and market price.
Yield to Maturity (YTM)
The rate of return (percentage) paid if the investor buys and holds it until maturity. The calculation for YTM is based on the coupon rate, length of time to maturity, and market price (assumes that interest paid over the life of the bond will be reinvested at the same interest rate).