Features of Bond
Features of Bond
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In general, a bond is a legally binding agreement between a borrower and a lender that specifies:
How much is being borrowed – Par (face) Value
The "interest rate" being charged – Coupon Rate
When the "interest" payments will be made and how much are they – Coupon Payment
When the contract will end/mature – Maturity date
Because all these four features are fixed, a bond is also called a fixed income security.
Learning by Example: Bond Features
Learning by Example: Bond Features
Above is a real corporate bond issued by the Green Giant Company in the year 1967. Let's go through the features of it so that you might have a better impression of the four features of the bond.
Let's start with the face value (par value) of the bond. It is $1000, as printed literally on the face of the bond. This number is the most obvious number on this bond.
As it prints "...assigns the principle of one thousand dollars on August 1, 1992, in coins or currency of the United States of America." So here it confirms the principle (face value) of the bond is $1000, as well as maturity date is August 1st, 1992.
It further prints "and to pay interest on said principle sum at the rate of 4 1/4% per annum...from August 1 or February 1..." This implies the coupon rate is 4.25%, and is paid on semi-annual basis. It means the bond will pay a coupon of $212.5 ($1000*4.25%/2) on every February 1 and August 1 from 1968 to 1992. The coupon payment equals the coupon rates times the par value divided by the number of payments per year.
To sum up, the par value of the bond is $1000, the coupon rate is 4.25%, the coupon payment is $212.5 on semi-annual base, and the maturity date is August 1, 1992. In other words, the maturity is 25 years, with 2*25 = 50 coupon payments.
Why Called Coupon?
Why Called Coupon?
To this point, you probably already heard (repeatedly from me) that the fixed "interest rate" of the bond is not the real interest rate the market use to discount future cash flows. But why does this "interest" payment called "coupon"? Other than trying to clarify it is not the real interest rate?
I don't know precisely why, but I can give you some useful clues though. In the early days of bond, sometimes each fixed interest payment was printed as appendix with the bond, so the bond holder can cut it out and go cash it. The below is a real bond issued by Chinese government in the year 1913 traded in the US market. As you can tell, these interest appendix look exactly like a coupon book. Maybe that's why this interest payment is called coupon payment.
As a matter of fact, if you watch closely, you will see each coupon has its payment date printed on it. That is amazingly detailed.
Another example is Spanish-American War 3% Coupon Bond of 1898 below.
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