A bond is a type of security under which the issuer owes the holder a debt, and is obliged – depending on the terms – to repay the principal of the bond at the maturity date as well as interest over a specified amount of time.

The interest is usually payable at fixed intervals: semiannual, annual, and less often at other periods. Thus, a bond is a form of loan or IOU.

The most common forms include municipal, corporate, and government bonds. Very often the bond is negotiable, that is, the ownership of the instrument can be transferred in the secondary market. This means that once the transfer agents at the bank medallion-stamp the bond, it is highly liquid on the secondary market. The price of a bond in the secondary market may differ substantially from the principal due to various factors in bond valuation.

Issuance

Bonds are issued by public authorities, credit institutions, companies and supranational institutions in the primary markets. The most common process for issuing bonds is through underwriting. When a bond issue is underwritten, one or more securities firms or banks, forming a syndicate, buy the entire issue of bonds from the issuer and resell them to investors.

The security firm takes the risk of being unable to sell on the issue to end investors. Primary issuance is arranged by bookrunners who arrange the bond issue, have direct contact with investors and act as advisers to the bond issuer in terms of timing and price of the bond issue.

Features

Principal: Nominal, principal or face amount is the amount on which the issuer pays interest, and which, most commonly, has to be repaid at the end of the term. Some structured bonds can have a redemption amount which is different from the face amount and can be linked to the performance of particular assets.

Maturity: The issuer is obligated to repay the nominal amount on the maturity date. As long as all due payments have been made, the issuer has no further obligations to the bond holders after the maturity date. The length of time until the maturity date is often referred to as the term or tenor or maturity of a bond. The maturity can be any length of time, although debt securities with a term of less than one year are generally designated money market instruments rather than bonds.

 There are four categories of bond maturities:

• Short term (bills): maturities between zero and one year
• Medium term (notes): maturities between one and ten years
• Long term (bonds): maturities between ten and thirty years
• Perpetual: no maturity Period

Coupon: The coupon is the interest rate that the issuer pays to the holder. For fixed rate bonds, the coupon is fixed throughout the life of the bond. For floating rate notes, the coupon varies throughout the life of the bond and is based on the movement of a money market reference rate (often LIBOR).

Yield: The yield is the rate of return received from investing in the bond. It usually refers to one of the following: 

• The current yield, or running yield: the annual interest payment divided by the current market price of the bond.
• The yield to maturity is an estimate of the total rate of return anticipated to be earned by an investor who buys a bond at a given market price, holds it to maturity, and receives all interest payments and the capital redemption on schedule.  It is a more useful measure of the return on a bond than current yield because it takes into account the present value of future interest payments and principal repaid at maturity.

Credit quality: The quality of the issue refers to the probability that the bondholders will receive the amounts promised at the due dates. In other words, credit quality tells investors how likely the borrower is going to default. This will depend on a wide range of factors. High-yield bonds are bonds that are rated below investment grade by the credit rating agencies. As these bonds are riskier than investment grade bonds, investors expect to earn a higher yield. These bonds are also called junk bonds.

Market price: The market price of a tradable bond will be influenced, among other factors, by the amounts, currency and timing of the interest payments and capital repayment due, the quality of the bond, and the available redemption yield of other comparable bonds which can be traded in the markets.

Types of Bonds

Bonds are classified into different categories as per the model of return and validities of legal obligations. The prevailing types of bonds in the public debt market are

Fixed-rate bonds: These have interest payments ("coupon"), usually semi-annual, that remains constant throughout the life of the bond. Other variations include stepped-coupon bonds, whose coupon increases during the life of the bond.

Floating rate notes: These have a variable coupon that is linked to a reference rate of interest, such as Libor or Euribor. For example, the coupon may be defined as three-month USD LIBOR + 0.20%. The coupon rate is recalculated periodically, typically every one or three months.

Inflation-indexed bonds: These are the bonds in which the principal amount and the interest payments are indexed to inflation. The interest rate is normally lower than for fixed rate bonds with a comparable maturity.

Perpetual bonds: These are fixed-security investment options whereby issuers do not have to return the principal amount to the purchaser. This investment type does not have any maturity period, and customers benefit from steady interest payments for perpetuity.