Unit 3
Meaning of Bond
A bond is a long-term debt instrument issued by governments, public sector undertakings,
financial institutions, or companies to raise funds from investors. When an investor purchases a
bond, they are lending money to the issuer in return for a fixed periodic interest (coupon) and
repayment of the principal amount (face value) at a specified future date called maturity. Bonds
are considered fixed-income securities because they provide predictable income over their life.
Features of a Bond
1. Face Value (Par Value)
The face value of a bond is the amount stated on the bond certificate and represents the principal
amount that the issuer promises to repay to the bondholder at maturity. It is also the value on which
interest payments are calculated. Face value remains constant throughout the life of the bond,
regardless of its market price fluctuations.
2. Coupon Rate
The coupon rate refers to the rate of interest paid by the bond issuer on the face value of the
bond. It is usually expressed as a percentage and determines the periodic income received by the
investor. A fixed coupon bond pays a constant interest amount throughout its life, providing income
certainty to the bondholder.
3. Coupon Payment
Coupon payment is the actual interest amount paid to the bondholder, generally on an annual or
semi-annual basis. It is calculated by applying the coupon rate to the face value of the bond. These
regular payments make bonds attractive to investors seeking stable and predictable income.
4. Maturity Period
The maturity period is the length of time after which the issuer repays the face value of the bond
to the investor. Bonds can be short-term, medium-term, or long-term depending on their maturity.
Longer maturity bonds generally carry higher risk due to interest rate fluctuations.
5. Market Price
The market price of a bond is the price at which it is traded in the market. It may be above, below,
or equal to its face value depending on changes in interest rates, credit rating of the issuer, and
market conditions. Market price fluctuates continuously, unlike face value which remains fixed.
6. Yield
Yield refers to the return earned by an investor on a bond, taking into account interest income and
capital gain or loss. Common measures include current yield and yield to maturity (YTM). Yield
helps investors compare bonds with different prices and coupon rates.
7. Credit Risk
Credit risk is the risk of default by the bond issuer in paying interest or principal. Bonds issued by
governments usually have low credit risk, while corporate bonds may carry higher risk. Credit rating
agencies assess this risk and assign ratings to bonds.
8. Liquidity
Liquidity refers to the ease with which a bond can be converted into cash without significant loss
of value. Bonds that are actively traded in secondary markets have higher liquidity. Liquidity is an
important consideration for investors who may need funds before maturity.
9. Tax Treatment
Interest income earned from bonds may be taxable or tax-exempt, depending on the type of bond
and applicable tax laws. Some government and municipal bonds offer tax benefits, making them
attractive to investors in higher tax brackets.
10. Transferability
Bonds are generally transferable instruments, meaning they can be bought and sold in the
secondary market. This feature provides flexibility to investors, allowing them to exit their
investment before maturity if required.
11. Indenture
An indenture is a formal legal document that specifies the terms and conditions of a bond or
debenture issued by a company, government, or financial institution. It acts as a contract between
debenture issued by a company, government, or financial institution. It acts as a contract between
the issuer and the bondholders, clearly defining the rights, obligations, and responsibilities of both
parties. The indenture ensures transparency and protects the interests of investors.