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Bond Terms

Accrued interest: Interest earned on a bond but not yet paid to the investor.

Basis point: One one-hundredth of 1%. Yield differences among fixed-income securities are stated in basis points.

Bond: A type of security that pays a fixed amount of interest at a regular interval over a certain period of time. Bonds are debt and are issued for a period of more than one year. When an investor buys bonds, he or she is lending money to some other party, usually a corporation or government.

Bond indenture: In corporate bonds, the contract that states the promises of an issuer and the rights of investors.

Bond rating: A bond's rating is like a person's credit rating. A letter grade from a rating agency indicates the risk of default on corporate or municipal bonds. Rating agencies (Moody's is the largest) assign a rating when a bond is issued. They continue to monitor the bond and will change the rating if the issuer's financial condition changes. The highest rating is AAA (Aaa for Moody's). Bonds rated BBB (or Baa) and above are considered investment grade. Anything below is a junk bond, which typically carries a higher interest rate to compensate for risk. Bonds with a D rating (C for Moody's) are in default.

Callable bond: A bond that is redeemable by the issuer prior to the maturity date at a specified price at or above par. When interest rates fall, corporations frequently "call" their bonds, because the company can sell new bonds at a lower interest rate and pay off the older, more expensive bonds with the proceeds of the new sale.

Call premium: A dollar amount, usually stated as a percent of the principal amount called, paid by the issuer as a "penalty" for calling a bond.

Corporate bonds: Debt instruments issued by private companies. They have a face value of $1,000.

Convertible bond: A security that can be converted into shares of the company that issues the bonds. The price of the conversion is generally set high enough to make it worthwhile only if the stock increases in price significantly. Convertible bonds are very complicated.

Coupon: The interest rate paid on a bond.

Coupon rate (coupon yield): The interest rate stated on a bond, expressed as a percentage of the principal, or face value.

Current yield: See yield.

Discount: The amount by which a bond's face value exceeds its market price.

Discount note: Short-term debt obligations issued at discount from face value, with maturities ranging from overnight to 360 days. These notes have no periodic interest payments; the investor receives the note's face value at maturity.

Federal discount rate: The rate the Federal Reserve charges on loans to member banks.

Federal funds rate: The interest rate charged by banks on loans to other banks. The Federal Reserve maintains control over this rate by adding or withdrawing reserves from the banking system. Economists and investors study changes in the federal funds rate for clues to what Federal Reserve is planning to do.

Face value: See par.

Interest: Compensation paid for the use of money. Interest on a bond is expressed as an annual percentage rate.

Investment-grade bond: A bond rated Baa or BBB or above.

Junk bond: A high-risk, non-investment-grade bond with a low credit rating, usually BB or lower. Because it is risky, it usually has a high yield. The opposite of an investment-grade bond.

Long bond: A bond with a maturity of more than 10 years is called a long bond, a long-term instrument or a long-term note.

Market Price: The purchase price of a bond; what an investor pays for it.

Maturity (Maturity date): The date on which a bond becomes due for payment.

Medium bond: A bond with a maturity between two and 10 years.

Municipal bonds: Also known as "munis," these are bonds issued by a state or local government. They are not subject to taxes if they are public purpose bonds. Private purpose municipal bonds, however, are taxable unless specifically exempted.

Non-callable bond: A bond that cannot be called for redemption by the issuer before its specified maturity date.

Par (par value): The amount repaid to the investor when the bond matures. Corporate bonds usually have a par value of $1000, municipal bonds $5000, and federal bonds $10,000).

Principal: The face amount of a bond, payable at maturity.

Premium: The amount by which the price of a security exceeds its principal amount.

Principal (principal amount): The amount borrowed, or the part of the amount borrowed which remains unpaid (excluding interest.)

Price: The price of a bond goes up and down with interest rates. As rates go up, the price of the bond goes down, because that particular bond becomes less attractive (i.e., pays less interest) when compared to new bonds being issued based on the current interest rate. As rates go down, the price of an existing bond goes up. The price also fluctuates in response to the risk perceived for the debt of the particular organization. Risk associated with a bond can also affect the price; for instance, if the company that issued the bond is near bankruptcy.

Redemption: At call or maturity, bonds are usually redeemed at "par," meaning the company pays back exactly what the bondholders paid it way back when.

Short bond: A bond with a maturity of less than two years is called a short bond, a short-term instrument or short-term note.

Strip: A bond, issued by the U.S. Treasury, whose two components, interest and repayment of principal, are separated and sold individually as zero-coupon bonds. Strip stands for Separated Trading of Registered Interest and Principal of Securities.

Trade date: The date when the purchase or sale of a bond is executed.

Treasury Bond (U.S. Treasury Bond): A negotiable, interest-bearing bond issued by the U.S. government. Treasury bonds have a maturity of more than seven years, are exempt from state and local taxes, and interest is paid semi-annually.

Treasury Note: T-notes are longer-term government debt instruments with maturities from one to 10 years.

Treasury Bill (T-Bill): A negotiable, interest-bearing debt obligation issued by the U.S. government that is exempt from state and local taxes and has a maturity of one year or less.

Yield: The ratio of interest to the actual market price of the bond, stated as a percentage. A bond that has a current market price of $1,000 and pays $70 per year in interest would have a current yield of 7%.

Yield curve: A line tracing relative yields on a type of security over a range of maturities ranging from three months to 30 years.

Zero-coupon bond: A bond, sold at a deep discount, where no periodic interest payments are made. The investor receives one payment, which includes principal and interest, at redemption (call or maturity).

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