Bonds. Explanation needed.

Yes, that's the bond coupon of the bond.

Aren't you in your mid 20's?

As I've mentioned before when you were really caught up on blue chips, most would suggest at your age that you should be looking at equity funds. Forget about the income for now and look for some serious growth.

In general there are two types of bonds: Zero-Coupon Bonds and Coupon Bonds.


Bond Terminology:

Face Value = Notional amount used to calculate interest payments

Coupon Rate = Determines the amount of each coupon payment, expressed as an APR with the appropriate compounding rate

Coupon Payment = (Coupon Rate*Face Value) / Number of Coupon Payments per Year

Yield to Maturity (YTM) = Internal Rate of Return (IRR) of the Coupon Bond


Zero-Coupon Bond:

- Pay face value at maturity
- No coupon interest payments

If a one year zero-coupon bond with face value of $100 has a price of $96.62, then its YTM can be calculated as follows:

Price = Face Value/(1+YTM)^n
96.62 = 100/(1+YTM)^1
This gives a YTM of 3.5%


Coupon Bonds:

- Pay face value at maturity
- Pay regular coupon interest payments

Let's say you buy a 5-year US treasury bond of $1000 with coupon rate of 5% and semi-annual coupons, then the coupon payments you will receive every six months can be calculated as follows:

Coupon Payment = (Coupon Rate*Face Value) / Number of Coupon Payments per Year = (5%*1000)/2 = $25

The price and YTM formula for a coupon bond is pretty complicated and you will need Excel to solve it. If you want me to show you can example of that, I'd be happy to.

(no message)

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You're right. I'm now pro index funds or high yield ETFs having gotten out of all my blue chips.
I am just curious about opening up a small bond position at some point.

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Just remember the price of the bond is only relevant if you plan on trading it. If you expect your children to go to college in 20 years and get a 20 year bond, you will get the entire amount in 20 years. If interest rates increase, they will sell for less if you need to get your money out in 10 years, but you will be given the actual amount you expected if you hold till maturity. It's just relatively less desirable if interest rates in the market are higher.

ex: why would I buy a bond with a 4% interest rate when the going rate is 6%?

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So buying a long term bond is always a complete guess?

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Buying bonds can be a great tool if you want a way to make a smaller, but less risky return for a given time period.

If you buy a $1,000, 10 year bond at a 5% interest rate, you will get $50 per year for 10 years, and $1,000 in 10 years. That isn't a guess.

The guess is if you decide to sell it in 5 years.

If market interest rates moved from 5% to 6%, you would sell that $1,000 bond for less than $1,000. If the market interest rate moved to 4%, you would sell that bond for more than 1k at year 5.

That is where the guess is, but there is no guess at all if you plan to hold till maturity. Unless the company defaults, you will get exactly what was stated (with the one exception if there is a clause allowing for early payment, think refinancing mortgages but for the company).

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Just as if you bought a dairy cow for milk, you don't necessarily care what the price of beef is doing because you're goal is the milk production from that cow.

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Good analogy.



And to the OP, as South said...

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Unless the company defaults, you will get exactly what was stated

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This is the only variable if you are definitely holding the bond to maturity and hence the ratings.