Bonds and How They Work
In order to fund daily business operations or finance special projects, companies and governments issue bonds. Buying a bond means you’re loaning your money for a specific time period, at a specific interest rate, to the issuer of that bond be it General Electric or Uncle Sam.
In exchange for purchasing that bond, (or loaning them money), the bond owner promises to pay you a specified interest for each year you own the bond and promises to return your principal at the bond’s “maturity”. When it’s time for the loan, or bond, to be paid back, the length of time to bond maturity is called it’s “term”. If a bond is “called”, then this bond is of the type that can be paid out earlier than its maturity.
The bond has what is called a “face or par value”. The amount of interest debts paid on this bond is known as its “coupon”.
So, if a bond has a par value of $1,000 and is paying interest at 7% a year, it has a $70 coupon. If the bond pays out semi-annually, you would receive two payments of $35 spaced six months apart. To express this in another way, a bond with a “par value“ of $1000 has a $70 “coupon yield”, based on an interest rate of 7% per annum if held to “maturity”: (Coupon rate divided by price equals yield).
