You need to know how to read bonds in the language of corporate finance to understand their potential impact on your corporation. Look in the finance portion of any newspaper (for example, The Wall Street Journal) and you’ll see information about the bond market. This data about specific bonds is meant to help buyers and sellers make effective decisions regarding the potential to invest in bonds or issue their own.
The exact information provided depends a lot on the types of bonds being described. Following is a list of common information about bonds that may improve your vocabulary a bit and make sure you know how to read bonds in the language of corporate finance:
Ask: The ask price is the price at which the seller is attempting to sell the bond. If this amount is above the bid price, no sale will be made until the buyer and seller give in and accept the price of the other party; the difference is called the spread.
Bid: The bid is the price at which the buyer is attempting to buy a particular bond. If this is below the ask price, no sale will be made until the buyer and seller agree on a compromise; the difference is called the spread.
Coupon/Rate: The terms coupon and rate refer to the interest rate generated on a bond. This interest rate is expressed as a percentage with up to three decimal places.
Credit Quality Ratings: When bonds are issued, the issuers are asking others to loan them money through the purchase of the bond. Just as any individual getting a mortgage or credit card must undergo a credit assessment, so too must corporations issuing bonds.
The credit quality rating on a bond is performed by a credit rating agency, and the rating is then provided to the public in order to help prospective buyers assess the risk of the issuing corporation defaulting. Standard & Poor’s (S&P) and Moody’s are the two primary rating agencies. Each uses a slightly different rating system, but their purpose is generally the same.
| S&P | Moody’s | Interpretation |
|---|---|---|
| AAA | Aaa | Highest rated; lowest risk |
| AA | Aa | Very good; low risk |
| A | A | Somewhat good; low risk |
| BBB | Baa | Moderately rated; low risk but susceptible to troubles; may not be able to withstand economic or market fluctuations |
| BB | Ba | Susceptible to troubles; stable only as long as the market or economy remains stable; junk |
| B | B | Moderately high risk; junk |
| CCC | Caa | High risk; junk |
| CC | Ca | Very high risk; junk |
| C | C | No interest income bonds |
| D | D | Already in default |
Face Value/Par Value: The face value or par value is the amount of the principal repayment on the bond. If this value isn’t listed, you can pretty much assume that it’s $1,000 per bond. Nevertheless, before actually taking any action, be sure to confirm the value because variations do exist and range a great deal.
Issuer: The issuer is the organization that is issuing the bond.
Maturity/Maturity Date: The maturity or maturity date can be listed in one of two ways: either as a duration of time (for example, one year, ten years, and so forth) or a date (for example, Nov. 2012; Feb. 15, 2019; and so on).
In the case of the former, the bond matures in an exact duration of time after the purchase date. In the case of the latter, the bond matures on the date listed.
Price: Where a lot of people start to get confused with bonds is when they start talking about price, yield, and the relationship between them. The reason for this is that price isn’t just listed as the nominal face value of the bond; it’s actually listed as a percentage of the face value.
So, if a bond is listed at 100.00, it’s selling at the exact face value of the bond. If the bond is selling below face value, say, at 99.95, then it’s selling at 99.95 percent of the face value. If the price is 101.01, it’s selling at 101.01 percent of the face value.
A bond that sells for under face value is selling at a discount, whereas a bond selling above face value is selling at a premium. At the end, the principal repayment is still going to be the face value of the bond, but the bond itself can sell for higher or lower than the principal repayment.
Price change: Price change refers only to the amount the price has changed since the last period, which can be anywhere from one day to one year, depending on where you’re getting your information. It can be expressed in two ways:
In nominal terms, the price change is expressed in terms of the dollar increase or decrease.
In ratio terms, the price change is expressed as a percentage of the previously reported price.
Volume: This term describes the volume of a particular bond being exchanged. Rather than providing information about the value of any particular bond, the volume describes the total value of all bonds of a particular type being sold.
So if someone were to issue and successfully sell ten bonds worth $10 each, the volume would be $100 during that time period. In the next period, if only one person who bought that bond were to resell the bond, the volume would drop to $10.
Yield: Yield refers to the amount of returns that a bond generates at a given price. That’s why yield is related to price — because the amount of returns on a particular bond that an investor generates depends on the relationship between price and yield.
If a one-year bond yields $100 per year and the market price of the bond was $100, then the yield is $0 or 0 percent. On the other hand, if the price was only $50, the yield is $50 or 100 percent.
Yield, also known as current yield, refers specifically to the annual amount of interest paid divided by the market price of the bond (which is then multiplied by 100 to make it a percentage). This annual yield differs from yield to maturity, which is the total amount of returns generated by holding the bond to maturity rather than over the course of a single year.
Yield change: This term refers only to the amount the yield has changed since the last period, which can be anywhere from one day to one year, depending on where you’re getting your information. It can be expressed in two ways:
In nominal terms, the yield change is expressed in terms of the dollar increase or decrease.
In ratio terms, the yield change is expressed as a percentage of the previously reported price.
Yield to maturity: Yield to maturity (YTM) is the value of the returns on a bond if the bond is held until its maturity date, given the current price. Of course if the price is higher, the yield will be lower because the percentage returns on the investment will be a lower proportion of the price.
Conversely, the yield will be higher if the price is lower. YTM assumes not only that the bond is held to maturity but also that no coupons are collected, which allows all coupons to continue accruing interest until the maturity date.