Bonds are debt securities that are essentially loans made by investors to borrowers (typically corporations or governments). They come with various features that define the terms and conditions of the bond. Here are some key features:
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Face Value (Par Value):
- This is the amount of money the bond will be worth at maturity and the amount the bond issuer agrees to pay the bondholder. It is typically fixed (e.g., $1,000).
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Coupon Rate:
- This is the interest rate that the bond issuer agrees to pay the bondholder. It is generally expressed as a percentage of the face value and can be fixed or variable. The coupon payments are typically made semi-annually, annually, or at other intervals.
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Coupon Payments:
- These are the interest payments made to bondholders during the life of the bond. They are based on the coupon rate, multiplied by the face value. For example, a bond with a 5% coupon rate and $1,000 face value would pay $50 annually.
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Maturity Date:
- This is the date on which the bond will mature, meaning that the issuer will pay back the principal amount (face value) to the bondholder. Maturities can range from a few months to several decades.
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Yield:
- This is the return that an investor can expect to earn on a bond. The yield is influenced by the bond’s coupon rate, its price, and the time to maturity. Different types of yields include current yield, yield to maturity (YTM), and yield to call (YTC), each providing different perspectives on the bond's potential returns.
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Credit Rating:
- Bonds are assigned credit ratings by agencies (e.g., Moody's, Standard & Poor's) that assess the creditworthiness of the issuer. Higher-rated bonds are considered safer (e.g., AAA, AA) and usually offer lower yields, while lower-rated bonds carry higher risk and therefore generally offer higher yields (e.g., junk bonds).
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Call Provision:
- Some bonds include a call provision that allows the issuer to redeem the bond before its maturity date at specified times and prices. This can be beneficial for issuers if interest rates decline, allowing them to refinance at lower rates.
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Put Provision:
- A put provision gives bondholders the right to sell the bond back to the issuer at a predetermined price before maturity, providing some protection against increased interest rates or decreased credit quality.
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Seniority and Subordination:
- Bonds can be classified based on their priority in the capital structure of an issuer. Senior bonds are paid first in the event of liquidation, while subordinated bonds are paid after senior debts. This impacts their risk and yield characteristics.
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Tax Treatment:
- The interest income from certain bonds can be tax-exempt (e.g., municipal bonds), while other bonds might be subject to federal, state, and local taxes. Investors often consider the after-tax yield when evaluating bonds.
These features contribute to the complexity and diversity of the bond market, allowing investors to choose bonds that align with their risk tolerance, investment goals, and income needs.