Bond Basics Glossary
Accrued interest
Interest deemed to be earned on a security but not yet paid to the investor.
Ask price
Price being sought for the security by the seller.
Basis point
One one—hundredth of 1 percent. Yield differences among fixed—income securities are stated in basis points.
Bearer security
A security that has no identification as to owner. It is presumed to be owned by the person who holds it. Bearer securities are freely negotiable, since ownership can be quickly transferred from seller to buyer by delivery of the instrument. However, note that in the United States it has not been legal to issue bearer bonds in the municipal or corporate markets since 1982. As a result, the only bearer bonds available in the secondary market are long—dated maturities issued before this date, which are becoming increasingly scarce. Among the disadvantages of bearer securities are that you must clip the coupons and present them to the trustee in order to receive your interest; and if the bonds are called, you will not automatically be alerted by the issuer or trustee.
Bid
The price at which a buyer offers to purchase a security.
Bond insurers and reinsurers
A partial list of bond insurers includes American Municipal Bond Assurance Corp. (AMBAC), ACA Financial Guaranty, AXA Re Finance, Financial Guaranty Insurance Co. (FGIC), Financial Security Assurance (FSA), Municipal Bond Insurance Association (MBIA), Radian Asset Assurance and XL Capital Assurance.
Bond swap
The sale of a bond and the purchase of another bond of similar market value. Swaps may be made to establish a tax loss, upgrade credit quality, extend or shorten maturity, etc.
Book—entry
A method of recording and transferring ownership of securities electronically, eliminating the need for physical certificates.
Callable bonds
Bonds which are redeemable by the issuer prior to the maturity date at a specified price at or above par.
Call premium
A dollar amount, usually stated as a percent of the principal amount called, paid by the issuer as a "penalty" for the exercise of a call provision.
Cap
The top interest rate that can be paid on a floating—rate security.
Closed—end investment company
An investment company created with a fixed number of shares which are then traded as listed securities on a stock exchange. After the initial offering, existing shares can only be bought from existing shareholders.
CMO (Collateralized Mortgage Obligation)
A bond, backed by a pool of mortgage pass—through securities or mortgage loans, which generally supports several classes of obligations. (See "REMIC.").
Collar
Upper and lower limits (cap and floor, respectively) on the interest rate of a floating—rate security.
Coupon
This part of a bearer bond denotes the amount of interest due, and on what date and where payment will be made. Bearer coupons are presented to the issuer’s designated paying agent for collection. With registered bonds, physical coupons don’t exist. (See "Registered bond.") The payment is mailed directly to the registered holder. Note that while bearer bonds are no longer issued in the United States and, hence, physical coupons are increasingly scarce, dealers and investors often still refer to the stated interest rate on a registered or book—entry bond as the "coupon.".
Current yield
The ratio of interest to the actual market price of the bond, stated as a percentage. For example, a bond with a current market price of $1,000 that pays $80 per year in interest would have a current yield of 8%.
CUSIP
The Committee on Uniform Security Identification Procedures, established under the auspices of the American Bankers Association to develop a uniform method of identifying securities. CUSIP numbers are unique nine—digit numbers assigned to each series of securities.
Dated date (or issue date)
The date of a bond issue from which the first owner of a bond is entitled to receive interest.
Default
Failure to pay principal or interest when due. Defaults can also occur for failure to meet non—payment obligations, such as reporting requirements, or when a material problem occurs for the issuer, such as a bankruptcy.
Debenture
Unsecured debt obligation, issued against the general credit of a corporation, rather than against a specific asset.
Discount
The amount by which the purchase price of a security is less than the principal amount, or par value.
Discount note. Short—term obligations issued at discount from face value, with maturities ranging from overnight to 360 days
They have no periodic interest payments; the investor receives the note’s face value at maturity.
Discount rate
The rate the Federal Reserve charges on loans to member banks.
Duration
The weighted maturity of a fixed—income investment’s cash flows, used in the estimation of the price sensitivity of fixed—income securities for a given change in interest rates.
Embedded option
A provision within a bond giving either the issuer or the bondholder an option to take some action against the other party. The most common embedded option is a call option, giving the issuer the right to call, or retire, the debt before the scheduled maturity date.
Extension risk
The risk that rising interest rates will slow the anticipated rate at which mortgages or other loans in a pool will be repaid, causing investors to find that their principal is committed for a longer period than expected. As a result, they may miss the opportunity to earn a higher rate of interest on their money.
Face amount
Par value (principal or maturity value) of a security appearing on the face of the instrument.
Federal funds rate
The interest rate charged by banks on loans to other banks. The Federal Reserve’s ability to add or withdraw reserves from the banking system gives it close control over this rate. Changes in the federal funds rate are sometimes studied by economists and investors for clues to Federal Reserve intentions.
Floating—rate bond
A bond for which the interest rate is adjusted periodically according to a predetermined formula, usually linked to an index.
Floor
The lower limit for the interest rate on a floating—rate bond.
General obligation bond
A municipal bond secured by the pledge of the issuer’s full faith, credit and taxing power.
Hedge
An investment made with the intention of minimizing the impact of adverse movements in interest rates or securities prices.
High—yield bond
Bonds issued by lower—rated corporations, sovereign countries and other entities rated Ba or BB or below and offering a higher yield than more creditworthy securities; sometimes known as junk bonds.
Investment—grade
Bonds considered suitable for preservation of invested capital by the rating agencies and rated Baa or BBB or above.
Issuer
An entity which issues and is obligated to pay principal and interest on a debt security.
Interest
Compensation paid or to be paid for the use of money. Interest is generally expressed as a percentage rate.
Junk bond
A debt obligation with a rating of Ba or BB or lower, generally paying interest above the return on more highly rated bonds; sometimes known as high—yield bonds.
Leverage
The use of borrowed money to increase investing power.
LIBOR (London Interbank Offered Rate)
The rate banks charge each other for short—term eurodollar loans. LIBOR is frequently used as the base for resetting rates on floating—rate securities.
Liquidity or Marketability
A measure of the relative ease and speed with which a security can be purchased or sold in the secondary market at a price that is reasonably related to its actual market value.
Maturity
The date when the principal amount of a security is payable.
Mortgage pass—through
A security representing a direct interest in a pool of mortgage loans. The pass—through issuer or servicer collects payments on the loans in the pool and "passes through" the principal and interest to the security holders on a pro rata basis.
Mutual fund
Also known as an open—end investment company, to differentiate it from a closed—end investment company. Mutual funds invest pooled cash of many investors to meet the fund’s stated investment objective. Mutual funds stand ready to sell and redeem their shares at any time at the fund’s current net asset value: total fund assets divided by shares outstanding.
Non—callable bond
A bond that cannot be called for redemption by the issuer before its specified maturity date.
Offer
The price at which a seller will sell a security.
Offering price
The price at which members of an underwriting syndicate for a new issue will offer securities to investors.
Par value
The principal amount of a bond or note due at maturity.
Paying agent
Place where principal and interest are payable—usually a designated bank or the office of the treasurer of the issuer.
Premium
The amount by which the price of a security exceeds its principal amount.
Prepayment
The unscheduled partial or complete payment of the principal amount outstanding on a mortgage or other debt before it is due.
Prepayment risk
The risk that falling interest rates will lead to heavy prepayments of mortgage or other loans—forcing the investor to reinvest at lower prevailing rates.
Primary market
The market for new issues.
Principal
The face amount of a bond, payable at maturity.
Ratings
Designations used by credit rating agencies to give relative indications of credit quality.
Registered bond
A bond whose owner is registered with the issuer or its agent. Transfer of ownership can only be accomplished when the securities are properly endorsed by the registered owner.
Reinvestment risk
The risk that interest income or principal repayments will have to be reinvested at lower rates in a declining rate environment.
REMIC (Real Estate Mortgage Investment Conduit)
Because of changes in the 1986 Tax Reform Act, most CMOs are now issued in REMIC form to create certain tax advantages for the issuer. The terms REMIC and CMO are now used interchangeably.
Revenue bond
A municipal bond payable from revenues derived from tolls, charges or rents paid by users of the facility constructed with the proceeds of the bond issue.
Secondary market
Market for issues previously offered or sold.
Settlement date
The date for the delivery of securities and payment of funds.
Sinking fund
Money set aside by an issuer of bonds on a regular basis, for the specific purpose of redeeming debt.
Sinker
A bond with a sinking fund.
Swap
Simply, the sale of a block of bonds and the purchase of another block of similar market value. Swaps may be made to achieve many goals, including establishing a tax loss, upgrading credit quality, extending or shortening maturity, etc.
Trade date
The date when the purchase or sale of a bond is transacted.
Transfer agent
A party appointed by an issuer to maintain records of securities owners, to cancel and issue certificates, and to address issues arising from lost, destroyed or stolen certificates.
Trustee
A bank designated by the issuer as the custodian of funds and official representative of bondholders.
Unit investment trust
Investment fund created with a fixed portfolio of investments that never changes over the life of the trust. As investments within the trust are paid off, they provide a steady, periodic flow of income to investors.
Yield
The annual percentage rate of return earned on a security. Yield is a function of a security’s purchase price and coupon interest rate.
Yield curve
A line tracing relative yields on a type of security over a spectrum of maturities ranging from three months to 30 years.
Yield to call
A yield on a security calculated by assuming that interest payments will be paid until the call date, when the security will be redeemed at the call price.
Yield to maturity
A yield based on the assumption that the security will remain outstanding to maturity. It represents the total of coupon payments until maturity, plus interest on interest, and whatever gain or loss is realized from the security at maturity.
Zero—coupon bond
A bond on which no periodic interest payments are made. The investor receives one payment—which includes principal and interest—at redemption (call or maturity). (See "Discount note.").