Bonds have certain characteristics that distinguish them from other investment alternatives. Coupon Rate The bond’s coupon rate (also known as the coupon, coupon yield, or stated interest rate) is the interest rate printed on the certificate when the bond is issued. It reflects the total annual fixed rate of interest that will be paid. For example, Leslie Geradine Sherman, a retired teacher from Laramie, Wyoming, bought a 20-year, $1000 Running Paws Cat Food Company bond last week with a coupon rate of 7 percent that promises to pay her $70 in interest annually (bonds pay interest in two semiannual installments $35 in this instance). A disadvantage of bonds is that the investment does not provide the automatic benefit of compounding of interest; therefore, investors have no choice but to find other places to invest interest payments
Serial or Sinking Fund The coupon rate of a bond remains the same until the maturity date, when the face amount is due and the debt is required to be paid off (or retired). Corporate bonds often mature in 20 to 30 years. Occasionally, bonds are retired serially; that is, each bond is numbered consecutively and matures according to a prenumbered schedule at stated intervals. These investments are known as serial bonds. Many bonds include a sinking fund through which money is set aside with a trustee each year for repayment of the principal portion of the debt. The details about each bond issue are contained in its indenture. This written, legal agreement between a group of bondholders (representing each bondholder) and the debtor describes the terms of the debt by setting forth the maturity date, interest rate, and other factors.
Secured or Unsecured Bonds are issued as either secured or unsecured. A corporation issuing a secured bond pledges specific assets as collateral in the indenture or has the principal and interest guaranteed by another corporation or a government agency. In the event of default, the trustee could take legal action to seize and sell such assets. In the event of bankruptcy, the claims of secured creditors are paid first. An unsecured bond (or debenture) does not name collateral as security for the debt and is backed only by the good faith and reputation of the issuing agency. Although secured bonds might appear safer than unsecured bonds, this assumption may not be true. The strong financial reputations of many large corporations enable them to offer unsecured bonds that are safer than the secured bonds of many other companies. All federal government bonds are unsecured and are backed by the U.S. government.
Serial or Sinking Fund The coupon rate of a bond remains the same until the maturity date, when the face amount is due and the debt is required to be paid off (or retired). Corporate bonds often mature in 20 to 30 years. Occasionally, bonds are retired serially; that is, each bond is numbered consecutively and matures according to a prenumbered schedule at stated intervals. These investments are known as serial bonds. Many bonds include a sinking fund through which money is set aside with a trustee each year for repayment of the principal portion of the debt. The details about each bond issue are contained in its indenture. This written, legal agreement between a group of bondholders (representing each bondholder) and the debtor describes the terms of the debt by setting forth the maturity date, interest rate, and other factors.
Secured or Unsecured Bonds are issued as either secured or unsecured. A corporation issuing a secured bond pledges specific assets as collateral in the indenture or has the principal and interest guaranteed by another corporation or a government agency. In the event of default, the trustee could take legal action to seize and sell such assets. In the event of bankruptcy, the claims of secured creditors are paid first. An unsecured bond (or debenture) does not name collateral as security for the debt and is backed only by the good faith and reputation of the issuing agency. Although secured bonds might appear safer than unsecured bonds, this assumption may not be true. The strong financial reputations of many large corporations enable them to offer unsecured bonds that are safer than the secured bonds of many other companies. All federal government bonds are unsecured and are backed by the U.S. government.
Registered and Issued By law, all bonds issued now are registered bonds. This provides for the recording of the bondholder’s name so that checks or electronic funds transfers for payment of interest and principal can be safely forwarded when due. The Internal Revenue Service is notified of the payments as well. A registered bond can be transferred only when the registered owner endorses the transaction.
Book Entry All bonds today are issued in book-entry form, which means that certificates are not issued. Instead, an account is set up in the name of the issuing organization or the brokerage firm that sold the bond, and interest is paid into this account when due. In the past, all corporations issued bearer bonds (also called coupon bonds because owners redeemed the coupons for interest). Some of these older bonds are still traded today.
Callable An issuer might desire to exercise a call option when interest rates drop substantially. For example, assume a company issues bonds paying a $90 annual dividend (9 percent coupon rate). When interest rates drop perhaps to 7 percent, the 9 percent bonds may represent too high a cost for borrowing to the corporation. If the bonds have a callable feature, according to dates and terms detailed in the indenture, the issuer can redeem the bonds before the maturity date. In such a case, the issuer repurchases the bond at par value or by paying a premium, often one year’s worth of interest. Approximately 80 percent of long-term bonds are classified as callable.
Book Entry All bonds today are issued in book-entry form, which means that certificates are not issued. Instead, an account is set up in the name of the issuing organization or the brokerage firm that sold the bond, and interest is paid into this account when due. In the past, all corporations issued bearer bonds (also called coupon bonds because owners redeemed the coupons for interest). Some of these older bonds are still traded today.
Callable An issuer might desire to exercise a call option when interest rates drop substantially. For example, assume a company issues bonds paying a $90 annual dividend (9 percent coupon rate). When interest rates drop perhaps to 7 percent, the 9 percent bonds may represent too high a cost for borrowing to the corporation. If the bonds have a callable feature, according to dates and terms detailed in the indenture, the issuer can redeem the bonds before the maturity date. In such a case, the issuer repurchases the bond at par value or by paying a premium, often one year’s worth of interest. Approximately 80 percent of long-term bonds are classified as callable.
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