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- WHAT IS A BOND?

Posted by Admin Posted on July 16 2018

WHAT IS A BOND?

 

A bond is simply a certificate which the borrower promises to repay within a certain time period. For the privilege of using the money, the government entity, municipality or company will agree to pay a certain amount of interest per year, usually an exact percentage of the amount loaned.

Bondholders do not own any part of the companies they lend to - they do not receive the benefits of dividends or the privilege to vote on company matters as stockholders would, and the success of the investment isn't related to that company's record in the market either. A bondholder is entitled to receive the amount that was agreed upon, as well as the principal of the bond.

Corporate bonds are generally issued in the denominations of $1000. This price is referred to as the face value of the bond - this is the amount that is agreed to be paid by the company at the time that it matures. Bond prices can differ from their face values, because the prices of the bonds are correlated to the current market rates. When these rates change, the value of the bond will as well. If one were to sell the bond before the time that it matures, the bond may be worth less than was initially paid. A callable bond is one that the issuer may choose to buy back at full face value before the maturity date.

There are three major features of bonds:

Issuing Organization

Maturity

Quality

Short Term Bonds mature in two years or less and long term bonds mature in ten or more. Intermediate is between two and ten years.

 

▼ What is bond quality?

Bond quality is the rating of the creditworthiness of an issuing organization. There are organizations that specialize in judging bond quality. The higher the rating, the lower the risk of the investment. The rating system uses letters A through D. The only bond considered to be risk free is the U.S. Treasury Bond.

▼ How does the bond rating system work?

Highest Quality

Moody's

Standard & Poor's

High Quality

Aaa

AAA

Good Quality

Aa

AA

Medium Quality

Baa

BBB

Speculative Elements

Ba

BB

Speculative

B

B

More Speculative

Caa

CCC

Highly Speculative

Ca

CC

In Default

-

D

Not Rated

N

N

▼ How do interest rates affect bond prices?

Generally bond prices and interest rates have an inverse relationship - as interest rates drop, bond prices rise and vice versa.

▼ How does maturity affect bond prices?

Bond prices are heavily influenced by maturity - the longer the maturity, the greater the change in price for a change in interest rates. If interest rates rise, it would make a larger difference in the 20 year bond, as opposed to a 10 year bond. Because of this, bond fund managers will attempt to change the fund's average maturity to anticipate changes in interest rates.

If you have any questions regarding accounting, domestic taxation, international taxation, IRS representation, U.S. tax implications of Real Estate  transactions or financial statements, please give us a call at 305-274-5811.

Source: Thomson Reuters

The information provided on the LBCPA Blog is a community service for general information purposes only, and should not be used as a substitute for consultation with professional advisors who specialize in the topics covered. Please refer to your advisors for specific advice on these subjects. The information is not intended to be used, and it cannot be used, for the purposes of avoiding U.S. Federal and/or State tax laws or the tax laws of any foreign jurisdiction.

These blogs contain general information only and Lord Breakspeare Callaghan LLC or any of the other companies or firms presenting information are not providing accounting, business, financial, investment, legal, tax, or other professional advice or services. Lord Breakspeare Callaghan LLC or any of the other companies or firms contributing with articles shall not be responsible for any loss sustained by any person who relies on this information.

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