Bond Mechanics

Interest that has accumulated on a bond from the last coupon payment date to the settlement date of a trade. The buyer pays the seller accrued interest in addition to the bond's market price. Calculated using the number of days since the last coupon payment, with day count conventions varying by bond type (30/360 for corporates and municipals, actual/actual for Treasuries).

Example: An investor purchases a corporate bond on March 15 with semi-annual coupon payments on January 1 and...

A feature in bond indentures granting the issuer the right to redeem (call) bonds before maturity, typically when interest rates decline. Includes a call premium (often a slight premium above par value) to compensate investors for early redemption. Call protection periods (usually 5-10 years) prevent calls during initial years. Callable bonds offer higher yields than non-callable bonds to compensate for reinvestment risk and price appreciation limits.

Example: A corporation issues 30-year bonds at par ($1,000) with a 7% coupon when rates are high. The bond ha...

The annual interest rate that a bond issuer promises to pay bondholders, expressed as a percentage of the bond's par (face) value. The coupon rate is fixed at issuance and determines the dollar amount of periodic interest payments, typically paid semi-annually. A bond with a 5% coupon rate and $1,000 par value pays $50 annually ($25 every six months).

Example: A corporation issues 20-year bonds with a 6% coupon rate at $1,000 par value. An investor who buys o...

An assessment of a borrower's creditworthiness and ability to meet debt obligations, issued by independent rating agencies. The two primary agencies are Moody's and Standard & Poor's (S&P), which use different rating scales. Ratings range from AAA/Aaa (highest quality) to D/C (default), with investment-grade bonds rated BBB-/Baa3 or higher and speculative-grade (high-yield or junk) bonds rated below investment-grade. Downgrades increase yields and decrease bond prices, while upgrades have the opposite effect.

Example: A pharmaceutical company's bonds are initially rated A by S&P. After a failed drug trial, S&P downgr...

A bond yield calculation measuring annual interest income as a percentage of the current market price. Current yield equals annual interest payment divided by current market price. It adjusts the coupon rate based on whether the bond trades at a premium or discount, but does not account for capital gains or losses realized at maturity (unlike yield to maturity). Current yield changes daily as bond prices fluctuate with market conditions.

Example: An investor owns a corporate bond with a $1,000 par value and 6% coupon ($60 annual interest). If th...

The risk that a bond issuer will fail to make required interest payments or repay principal at maturity. Default risk is measured by credit ratings from agencies like Standard & Poor's, Moody's, and Fitch, with higher-rated bonds (AAA) having lower default risk than lower-rated bonds (BB). Investors demand higher yields (default risk premium) to compensate for accepting greater default risk.

Example: An investor compares three $10,000 bonds with 10-year maturities: U.S. Treasury yielding 3.5% (zero ...

A bond trading below its par value (typically $1,000), occurring when market interest rates rise above the bond's coupon rate. For discount bonds, yield hierarchy is: Yield to Maturity (YTM) > Current Yield (CY) > Coupon Rate. Bondholders receive capital appreciation at maturity when the bond returns to par value, creating a taxable capital gain.

Example: A corporate bond with a 4% coupon rate (paying $40 annually per $1,000 face value) now trades at $92...

The date when a bond's principal (face value) is repaid to investors and interest payments cease. Bonds are classified by maturity: short-term (≤1 year), intermediate-term (1-10 years), and long-term (>10 years). Longer maturity bonds generally carry greater interest rate risk because their prices fluctuate more significantly when market rates change.

Example: A 30-year Treasury bond issued in 2020 has a maturity date of 2050. An investor purchasing it will r...

The face value of a bond, typically $1,000 for corporate and municipal bonds, representing the amount the issuer agrees to repay the bondholder at maturity. Par value serves as the basis for calculating coupon payments (e.g., a 5% coupon on $1,000 par = $50 annual interest). Bonds trade at premium (above par), discount (below par), or par in the secondary market based on interest rate movements and credit quality.

Example: An investor purchases a newly issued corporate bond with $1,000 par value and 6% coupon rate. She re...

A bond trading above its par value (above $1,000 for corporate bonds), which occurs when current market interest rates fall below the bond's fixed coupon rate. For premium bonds, the yield hierarchy follows: Coupon Rate > Current Yield > Yield to Maturity. If held to maturity, the investor will receive only par value, resulting in a capital loss that offsets the higher coupon income.

Example: An investor purchases a corporate bond with a 6% coupon when market rates are 4%. Because the bond p...

The difference between yields of two bonds, typically measured in basis points (1 bp = 0.01%). Yield spreads measure relative value and risk premiums between securities. Credit spreads (corporate bond yield minus Treasury yield) indicate the additional compensation investors demand for credit risk. Widening spreads signal increased risk perception, while narrowing spreads indicate improved creditworthiness or risk appetite.

Example: A BBB-rated corporate bond yields 5.50% while a comparable 10-year Treasury yields 3.75%. The credit...