The bond market is huge in more ways than one. It dwarfs the global stock market and is key in determining interest rates for everything from mortgages to car loans. It also has a language all its own and investors should be familiar with these key words and terms.
Coupon
Coupon refers to the percentage interest to be paid on a bond in the course of a year. The interest is usually payable semi-annually, although it can also be payable monthly, quarterly, and annually.
Maturity
The date the bond will be redeemed or paid off.
Price
The quoted price is usually based on the bond maturity at a price of par, or 100.00.
Yield
The term “yield” usually means “yield to maturity.” The yield to maturity takes into account the coupon payment, and considers whether the bond is maturing at a different price than its current price.
Bid
The price at which the trader will pay for a bond.
Offer (Ask)
The price at which the trader will sell a bond.
Bid-offer spread
The price difference between what the trader will buy a bond at and the price at which the trader will sell a bond. The difference on highly liquid and tradable government bonds is usually only a few cents.
Basis points
A basis point is a hundredth of a percentage point. For instance, if a yield moves from 5.5% to 5%, it has moved 50 basis points.
Spread over governments
Non-federal government bonds are often quoted on the basis of a yield spread over a comparable government bond. A corporate bond with a similar coupon and maturity date could easily be 100 basis points higher in yield than a federal government bond. Traders often bid and offer on a spread basis.
“Bells and Whistles”
What this refers to are special features for specific bonds. For example, a bond may mature on June 1, 2020, but there may be a special feature that allows the issuer to “call” the bond back on an earlier date, known as the call date. There are many other such special features.
Bond auctions
Federal governments in North America have moved to a system of auctions to sell their bonds to investors. Most bond dealers are allowed to bid at the auctions and then re-distribute the bonds to investors.
New issues
Most other governments and corporations use a different system of distributing new issues, namely offering them to investors through bond dealers. The bond dealers earn a commission for distributing the bonds to investors. The offering can be on a fixed price basis, or on the basis of a fixed yield spread to comparable federal government bonds.
Book-based bonds
In recent years bonds have gone “book-based,” meaning that the bonds are lodged with a central trustee and do not physically move from there. Instead, the dealers and institutions have accounts set up with the trustee, and when a bond trade takes place, the buyer’s account is credited with the bonds, while the seller’s account is debited. Most government and corporate bonds are book-based and investors are discouraged from taking physical possession of the bonds.
