Bond Foundations · Bonds Explained

Three terms with different jobs

Face value, also called par, is the reference principal specified by the security. The coupon rate determines contractual interest for a conventional fixed coupon bond. Maturity is the date principal is scheduled to be repaid. None of these terms tells you the price another investor will accept today.

Read the actual terms rather than assuming every bond pays twice a year. Annual, semiannual and quarterly schedules exist. A floating coupon can reset, an amortising bond repays principal gradually, and a perpetual instrument may have no fixed maturity.

Translate an annual rate into cash

Suppose a hypothetical bond has $5,000 face value and a 6% annual coupon paid semiannually. Annual interest is $300. Each regular half year coupon is $150. Buying at a premium of $5,200 does not increase those $150 coupons.

If four regular payments remain, the schedule is $150, $150, $150 and $5,150. Add principal only once, at the end. A spreadsheet that repeats principal in every period will dramatically overstate the investment value.

Recognise a zero coupon structure

A zero coupon bond pays no periodic coupon. Its return depends on the difference between the purchase price and the amount ultimately received, plus the time involved. A $1,000 payment bought for $900 is not an immediate $100 gain. You must wait and face the issuer and market risks during that period.

The same $100 difference implies a very different annualised return over one year than over ten years. A maturity date is therefore as important as the payment amount.

Check the calendar details

Record the next payment date, final maturity and payment convention. Holidays, settlement dates and unusual first or last coupon periods can affect a practical calculation. Keep the contractual schedule separate from a forecast about whether the borrower can actually honour it.

Try it yourself

A $4,000 bond pays a 3% annual coupon in two equal payments. What is each payment, and what is the final payment if all principal is repaid at maturity?

Show the worked answer

Each coupon is $60. The final scheduled payment is $4,060, consisting of $4,000 principal and the last $60 coupon.

Further reading

Educational material. Examples are hypothetical and do not recommend a security or a personal allocation. Contract terms and market conventions vary.

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