Bonds

• Bonds are interest-bearing securities issued by companies and government agencies in order to secure funding in the form of a loan. The price of a bond represents money that a buyer lends to the issuer. This is the bond's principal, or par value. The bond, in return pledges to pay interest on the par value at a specific rate until a definite maturity date. The bond pledges to pay the holder all interest and repay the bond's entire par value by this date.
  
  

Interest Yields and Risk Premiums

• Bonds issued by companies frequently offer higher interest yields than bonds issued by government agencies, such as a treasury or a municipality. The reason for this is that corporate bonds tend to carry higher risk than government bonds. Governments, unlike companies, can acquire necessary revenue through taxation. In return for assuming higher risk, companies compensate bondholders by paying a higher yield than the risk-free rate -- usually the yield on U.S. Treasury bonds. The difference between the yield on a given bond and the risk free rate is called the bond's risk premium.
  
  

Interest Accrual and Payments

• Corporate bonds are long-term -- more than one year -- securities that pay interest to holders at regular intervals until the bond reaches maturity. These interim payments, called coupon interest, are usually paid on a quarterly or semiannual basis and, in full, represent all interest accrued on the bond's par value. Under this arrangement, the final coupon interest payment is paid at maturity along with the full par value of the bond.
  
  

Market Values and Interest Rate Movements

• Corporate bonds are negotiable securities that can be bought and sold in the secondary bond market. A bond's market value fluctuates inversely with movements in the level of interest rates. For this reason, a rise in interest rates places downward pressure on a bond's market value and vice versa. This also means that a bondholder can sell a bond for more than its par value, or at premium.
  
  

The Call Provision

• In many cases, companies will include a call provision among the terms of a bond. A call provision indicates that the issuing company reserves the right to rebuy a bond from the holder at any time before the maturity date with little notice. In return, the bondholder receives the current market value. Companies include the call provision so that they can benefit in the event that interest rates decline. If interest rates decline, a company can call outstanding bonds paying higher rates, and then issue new bonds at a lower interest rate as a way to reduce costs.