Week 3 Discussion

Bonds

A bond is a long-term debt contract under which a borrower agrees to make payments of interest and principal on
speci�c dates to investors. There are four major types of bonds: treasury, corporate, municipal, and foreign.

Bonds have several key characterizes. Some of these characteristics include:

Par value: Also called face value, par value is the stated value of the bond, which is usually $1,000. The par
value represents the amount of money the issuer borrows and promises to pay at the maturity date.

Coupon interest rate: The stated annual rate of interest on a bond—also referred to as nominal rate.

Maturity date: the date on which the face value of the bond should be repaid. Bonds generally have a
speci�ed maturity. The speci�ed maturity of the bond is called its original maturity, or the number of years
to maturity at the time a bond is issued.

Yield to maturity: the rate of return earned on a bond if it is held to maturity. It is also the effective interest
rate earned by the bond.

Debentures: long-term bonds that are not secured by a claim on speci�c assets. Debentures are unsecured
bonds that depend on the general credit strength of the issuing corporation

Sinking fund: a fund created to retire bond issues. The existence of a sinking fund reduces the risk of default,
and hence, it increases the value of the bond issue.

Hybrid security: a security that has features of both equity and debt. An example is a convertible bond.

Convertible bond: a bond that is exchangeable, at the option of the bondholder, for common stock of the
issuing �rm.

Investors in bonds receive periodic coupon payments and principal after the maturity date. Just like stocks, the
price of a bond is equal to the discounted value of all future cash �ows. For bonds, the cash �ows include the
coupon interest payment and the par value. Unlike stocks, these cash �ows are predictable.