What are Bonds Features?
Introduction to Bonds
The most important features of a bond are:
Nominal, Principal or Face Amount - the amount on which the issuer pays interest, and which has to be repaid at the end.
Issue price - the price at which investors buy the bonds when they are first issued, typically $1,000.00. The net proceeds that the issuer receives are calculated as the issue price, less issuance fees, times the nominal amount.
Maturity date - the date on which the issuer has to repay the nominal amount. As long as all payments have been made, the issuer has no more 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.
Most bonds have a term of up to thirty years. In the market for U.S. Treasury securities, there are three groups of bond maturities:
short term (bills): maturities up to one year;
medium term (notes): maturities between one and ten years;
long term (bonds): maturities greater than ten years.
Coupon - the interest rate that the issuer pays to the bond holders. Usually this rate is fixed throughout the life of the bond. The name coupon originates from the fact that in the past, physical bonds were issued which had coupons attached to them. On coupon dates, the bond holder would give the coupon to a bank in exchange for the interest payment.
Coupon Dates - the dates on which the issuer pays the coupon to the bond holders. In the U.S., most bonds are semi-annual, which means that they pay a coupon every six months. In Europe, most bonds are annual and pay only one coupon a year.
Indenture or Covenants - a document specifying the rights of bond holders. In the U.S., federal and state securities and commercial laws apply to the enforcement of those documents, which are construed by courts as contracts. The terms may be changed only with great difficulty while the bonds are outstanding, with amendments to the governing document generally requiring approval by a majority (or super-majority) vote of the bond holders.
Optionality: a bond may contain an embedded option; that is, it grants option like features to the buyer or issuer:
callability - Some bonds give the issuer the right to repay the bond before the maturity date on the call dates. These bonds are referred to as callable bonds. Most callable bonds allow the issuer to repay the bond at par. With some bonds, the issuer has to pay a premium, the so called call premium. This is mainly the case for high-yield bonds. These have very strict covenants, restricting the issuer in its operations. To be free from these covenants, the issuer can repay the bonds early, but only at a high cost.
putability - Some bonds give the bond holder the right to force the issuer to repay the bond before the maturity date on the put dates.
call dates and put dates - the dates on which callable and putable bonds can be redeemed early. There are four main categories.
- A Bermudan callable has several call dates, usually coinciding with coupon dates.
- A European callable has only one call date. This is a special case of a Bermudan
- An American callable can be called at any time until the maturity date.
- A death put is an optional redemption feature on a debt instrument allowing the
beneficiary of the estate of the deceased to put (sell) the bond (back to the issuer) in
the event of the beneficiary's death or legal incapacitation. Also known as a "survivor's
Sinking Fund Provision - of the corporate bond indenture requires a certain portion of the issue to be retired periodically. The entire bond issue can be liquidated by the maturity date. If that is not the case, then the remainder is called balloon maturity. Issuers may either pay to trustees, which in turn call randomly selected bonds in the issue, or, alternatively, purchase bonds in open market, then return them to trustees.
Convertible Bond - lets a bondholder exchange a bond to a number of shares of the issuer's common stock.
Exchangeable Bond - allows for exchange to shares of a corporation other than the issuer.
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