Bonds are debt obligations of the issuing entity. There are many types of bonds, and a good way to distinguish them is based on the word that comes immediately before the word "bonds." For example, Treasury bonds are issued by the US Treasury while municipal bonds are issued by state and local governments and authorities. BondSavvy's focus is corporate bonds, which are issued by companies. A corporate bond issuer isn't always a corporation, but it will be some form of commercial entity such as a corporation or an LLC.
Corporate bonds create a number of obligations the issuing companies must fulfill that are more stringent than when companies
issue stock. With corporate bonds, issuing companies pay bondholders interest semi-annually. For example, suppose you owned a bond that
paid a 5% coupon and you owned 10 bonds. For each bond you owned, you would receive $50 of interest each year and that interest income would
be split into two semi-annual payments of $25 each.
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Below is a very basic introduction to individual corporate bonds. Please click to watch a comprehensive video on how corporate bonds work.
The par value of a bond is $1,000. This is also known as the face value of a bond. At a bond's maturity date, the issuing company is obligated to repay the bondholder the par value of the bond.
How are corporate bonds quoted?
While the par value of a bond does not change over the life of a bond, a bond's market value regularly changes. Individual corporate bonds are quoted as a percentage of their par value. Therefore, if a bond is quoted at 95.00, that bond is being valued at 95% of the $1,000 face value, or $950. Bonds that are quoted at less than their par value are said to be trading at a discount. Bonds trading above par value are said to be trading at a premium.
Since corporate bonds are priced off par value, bond investors can begin to evaluate whether a corporate bond is a good value by analyzing the bond's price, YTM, credit spread, leverage ratio, and other financial and trading metrics. This is a big advantage of individual bonds vs. bond funds, as bond funds trade off an arbitrary net asset value per share and lack the financial reporting and metrics of corporate bond issuers. Read our blog post to learn the advantages of bonds being priced off par value.
How much will I pay when I buy a bond?
Suppose you execute a corporate bond trade today where you buy 10 bonds at a price of 90.00. Here's how the math works:
First, each bond you bought cost $900, the market value of the bond. Since you bought 10 bonds, you will pay $9,000 in principal. In addition, you owe accrued interest since you will receive the full interest payment the next time the company pays interest. Corporate bonds pay interest semi-annually on typically the month and day of the maturity date and the date six months after this date.
For example, suppose a corporate bond pays interest on February 15 and August 15. If you purchased the bond on July 15, you would owe the selling bond holder interest that had accrued on the bond from February 15 until the bond trade settles on July 17, two business days after the traded was executed (known as "T + 2"). Please read our accrued interest blog post to see an example of the accrued interest calculation for an actual corporate bond trade.
What are financial covenants?
Financial covenants are effectively the do's and don'ts bond issuers must follow to stay in compliance with the bond indenture, a contract between issuer and bondholder. They govern the behavior of a company to help ensure bondholders are paid interest and receive a return of principal at maturity. An example of one financial covenant is the leverage ratio, which limits the amount of debt a company can incur relative to its EBITDA, or earnings before interest, taxes, depreciation and amortization. Some investors believe covenants add 'complexity' to bonds, but, once investors understand them, they will see how they are in place for the benefit of bondholders. Be sure not to look for similar covenants in a stockholders' agreement, as you will never seem them in there.