A fixed income security is defined as a financial obligation of an entity (an issuer) to pay a specified sum of money at specified future dates. Generally the financial obligation consists of a promise to pay interest and to repay principal (amount borrowed). The terms bonds and fixed income securities are often interchangeable.
Maturity or term to maturity is the number of years over which the issuer has promised to pay interest and to repay the principal. The maturity date of a fixed income security is the date after which the debt will no longer exist and at which time the issuer repays the amount borrowed.
The par value of a bond is the amount that the issuer agrees to repay the bondholder by the maturity date. Synonyms are the principal, face value, redemption value and maturity value. Bonds can have any par value. Bond prices are quoted as a percentage of par, in increments of 1/32.
The coupon rate, also called the nominal rate, is the annual rate of interest that an issuer agrees to pay. The annual amount of the interest payments is called the coupon, where:
Coupon = coupon rate x par value
Provisions for redeeming bonds are the agreement by the issuer on how the principal is repaid.
Coupon rate structures
Bonds have different coupon rate structures, depending upon the desired cash-flow pattern from the issuers’ perspective or other considerations.
Zero-coupon bonds are those where the coupons are not paid out periodically but accrued and realized at the date of maturity. The bonds are sold at a discount that reflects the accrued coupon.
Another type is accrual bonds, which are similar to zero-coupon bonds in the way that the coupons are accrued and realized at the maturity date, but the difference is that the bonds are issued at par, not at a discount.
Step-up notes are those where the coupon rate is increased over time. There are single step-up notes as well as multiple step-up notes.
Deferred coupon bonds are those which offer no coupon payments for a specific period, but a lump-sum payment of the accrued interest at a specified later date. Regular periodic payments of the coupons resume after the specified date.
Floating-rate securities, often called variable-rate securities, have coupon rates that are reset periodically according to particular rules or reference interest rate.
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