How to understand bond jargon

Unfamiliar terms can make investing in bonds seem like a daunting prospect but these simple definitions will help you get on your way.

Principal

Companies and governments usually issue bonds at a price of $100, so as an investor you can buy multiples of that amount, such as $1,000, $5,000 or $10,000.

The amount that the issuer borrows from an investor at the outset is known as the principal, or the nominal value or face value.  

Maturity date and term

The maturity date is important for investors because that is when the issuer must buy back the bonds and repay the principal.

On this date you’re likely to receive the face value of the bonds, as well as any final interest payments owed.

The term of a bond is the period between issue and maturity:

• Short term bond (term of less than one year)
• Medium term bond (term of one to three years)
• Long term bonds (term of three years or more)

Coupon rate

Throughout the term of the bond, you may receive interest payments at regular intervals. The amount of interest you receive each year is known as the coupon rate and is expressed as a percentage of the bond’s face value.

The coupon rate will either be fixed or floating, usually a fixed amount on top of a variable benchmark rate.

Yield

The coupon can also be referred to as the yield. If you are investing in bonds through the secondary market then you should also be aware of the phrase ‘current yield’.

Current yield

Sometimes also known as income yield or running yield, the current yield is calculated using the price at which a bond is trading on a stock exchange at the current time.

• Annual coupon rate ÷ the bond’s current market price x 100 = current yield

The current yield enables you to work out the actual rate of interest you will receive from a bond, taking into account the amount that you pay for it on the secondary market.

Example: 

• When a bond is issued with a 5% coupon, that interest rate, or yield, is based on the face value of $100
• But if you buy the bond for $90 on the secondary market the current yield would be 5.5% (5 ÷ 90 x 100)
• And if you buy the bond for $110 on the secondary market the current yield would only be 4.54% (5 ÷ 110 x 100)