7.1 Fixed-Income Securities: Defining Elements - 7.1 Fixed-Income Securities: Defining Elements Explained

Key Concepts

• Par Value
• Coupon Rate
• Maturity Date
• Yield to Maturity (YTM)
• Credit Risk

Par Value

Par Value, also known as face value, is the nominal value of a bond. It is the amount that the issuer agrees to repay the bondholder at the maturity date. Par value is typically set at $1,000 for corporate bonds and $100 for municipal bonds.

Example: If you purchase a corporate bond with a par value of $1,000, the issuer promises to repay you $1,000 when the bond matures.

Coupon Rate

The Coupon Rate is the annual interest rate that the issuer pays to the bondholder. It is expressed as a percentage of the par value and is typically paid semi-annually. The coupon rate determines the periodic interest payments received by the bondholder.

Example: A bond with a par value of $1,000 and a coupon rate of 5% will pay annual interest of $50 ($1,000 * 5%). This amount is usually paid in two installments of $25 each six months.

Maturity Date

The Maturity Date is the date on which the bond issuer repays the par value to the bondholder. At this date, the bond's life cycle ends, and the issuer fulfills its obligation to repay the principal amount.

Example: If a bond is issued with a maturity date of January 1, 2030, the issuer will repay the par value to the bondholder on that date.

Yield to Maturity (YTM)

Yield to Maturity (YTM) is the total return anticipated on a bond if it is held until it matures. It considers the bond's current market price, par value, coupon interest rate, and time to maturity. YTM is a comprehensive measure of a bond's return and is expressed as an annual rate.

Example: If a bond with a par value of $1,000, a coupon rate of 5%, and a current market price of $950 has a YTM of 6%, it means that the bond's total return, including interest payments and price appreciation, is expected to be 6% per year if held to maturity.

Credit Risk

Credit Risk is the risk that the bond issuer may fail to make timely interest payments or repay the principal amount at maturity. It is a critical factor in determining the bond's yield, with higher credit risk typically resulting in a higher yield to compensate investors for the additional risk.

Example: A corporate bond issued by a financially stable company will have lower credit risk compared to a bond issued by a startup with uncertain financial prospects. Investors may demand a higher yield for the latter to compensate for the increased risk.