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A bond is issued
with a stated value, known as the par, or face, value. This
is the value at which the bond will be bought back by the issuer upon its
maturity. Though there are exceptions to the rule, most bonds are issued
with a $1,000 par value. While a bond's current value can and usually does
fluctuate during its lifetime, this par value remains fixed. At issue,
most bonds also offer a fixed interest rate, or coupon rate. This
is the annual rate of interest, calculated as a percentage of par, that the
holder of the bond will earn. For example, if a $1,000 par value bond has
a 5 percent coupon rate, each year the holder of that bond will earn 5 percent
of $1,000, or $50 (5% x $1,000 = $50).
There are several yields with which bond investors must be
familiar, but the most important is the yield-to-maturity, or YTM.
This is the total return an investor receives from a bond, based on the annual
interest rate and any profit or loss realized on the sale of the bond.
Simply put, YTM is the yield calculation used to compare the value of bonds with
different issue and maturity dates, coupon rates, and par values.
Another important bond concept is present value -- the
assumption that, due to inflation, a specified sum of money received today will
be worth more than the same amount received at some point in the future.
Because bonds are based on the foundation of "payments over time," investors
should be aware of this relationship between the values of money received today
and the same amount received later. |
