What are bonds?

Bonds are debt instruments that are used by government and corporate to raise money on contractual basis. Generally bonds issuer promises a regular payment of interest which is known as bond’s coupon in finance parlance. In US the period for payment of coupon is every six months. Besides coupon, generally the bond issuer also promises to payback principal at the end of a particular time known as maturity of bond. The payment at maturity is equal to face value/par value of bond.

Coupon rate is the annual coupon payment divided by the face value of the bond. Coupon yield is coupon payment divided by the market price of the coupon.

Those bonds which do not offer any coupon are called zero-coupon or discount bonds.

Bond yield is similar to interest rate which the investor wants on the money he/she is lending to the bond issuer. It is dependent on the coupon rate, maturity, and risk associated with that particular bond.

Bonds issued by government are regarded as risk-free bonds, while those issued by corporate carry some risk of default depending on the company. This risk is reflected in the bond yield requirement. The bond yield of corporate is higher than of government bond. This gets adjusted through the price of the bond. Generally, if the coupon rate is higher than the yield then the bond’s price will be higher than its face value (premium), otherwise it will set at less than face value (discount). The risk associated with the corporate bonds is classified by rating agencies which classify the bonds based on their quality.