Use Golf to Understand Bonds
Think of your bonds as playing golf. Sometimes you make pars, birdies, and bogies.
Bonds are much the same way. If you buy a bond at the initial issue, it is like making a par. If you buy bonds at a premium (on the secondary market), it is like making a bogey. You’re paid higher than par. If you buy bonds at a discount it (on the secondary market) it is like making a birdie — you bought the bond at less than par.
This simple explanation works and lets your prospect understand bonds easier.
Par: Price equal to the face amount of a security; 100%. Par
Discount: A bond sold at less than par. Birdie
Premium: The amount by which the price of a security exceeds its principal amount. Bogey
Here are some terms about bonds worth learning and being familiar.
Callable: Subject to the payment of the principal amount (and accrued interest) before the stated maturity date, with or without payment of a call premium. Bonds can be callable under some different circumstances, including at the option of the issuer, or on a mandatory or extraordinary basis.
Call date: The date at which some bonds are redeemable by the issuer before the maturity date.
Call protection: Bonds that are not callable for a certain number of years before their call date
Call risk: The risk that declining interest rates may accelerate the redemption of a callable security, causing an investor’s principal to be returned sooner than expected. Therefore, investors may have to reinvest their principal at a lower rate of interest.
Marketability: A availability of a market to convert the bond to cash.
Market price or market value: For securities traded through an exchange, the last reported price at which a security was sold.
Maturity date: The date when the principal amount of the security becomes due and payable.
Non-investment grade: Bonds not considered suitable for preservation of invested capital; ordinarily, those rated Baa or below by Moody’s Investors Service, or BBB- or below by Standard & Poor’s Corporation. Bonds that are non-investment grade are also called high-yield bonds.
Risk: A measure of the degree of uncertainty and financial loss inherent in an investment or decision. There are many different risks, including:
- Call risk-The risk that declining interest rates may accelerate the redemption of a callable security, causing an investor’s principal to be returned sooner than expected. Therefore, investors may have to reinvest their principal at a lower rate of interest.
- The · credit risk-The risk that the obligor on the bonds will be unable to make debt service payments due to a weakening of their credit.
- Event risk-The risk that an issuer’s ability to make debt service payments will change because of unanticipated changes, such as a corporate restructuring, a regulatory change or an accident, in their environment.
- Market risk-Potential price fluctuations in a bond due to changes in the general level of interest rates.
- Underwriting risk-The risk of pricing and underwriting securities and then ultimately not being able to sell them to the investor.
Yield to call: A yield on a security calculated by assuming that interest payments will be paid until the call date when the security will be redeemed at the call price.
Yield to maturity: A yield on a security calculated by assuming that interest payments will be made until the final maturity date, at which point the issuer will repay the principal. Yield to maturity is essentially the discount rate at which the present value of future payments (investment income and the return of principal) equals the price of the security.
Zero-coupon bond: A bond for which no periodic interest payments are made. The investor receives one payment at maturity equal to the principal invested plus interest earned compounded semi-annually at the original interest rate to maturity.
High-yield bond: Bonds issued by lower-rated corporations, sovereign countries and other entities rated Ba or BB or below and offering a higher yield than more creditworthy securities; sometimes known as junk bonds.
Debenture: Unsecured debt obligation, issued against the general credit of a corporation, rather than against a specific asset.