What are Bonds?

Characteristics

Benjamin F. Edwards offers a wide range of bonds, such as corporate bonds, government bonds, and municipal bonds. Bonds are debt securities issued by corporations, governments, or other entities that pay fixed or variable interest rates to investors for a specific period of time. When the bond reaches maturity, the bond issuer generally returns the principal amount of the bond to investors. There are many types of bonds and the features, characteristics, and risks associated with bonds can vary significantly.

For most bonds, a bond’s coupon rate is the rate of interest it pays annually and is expressed as a percentage of its face value. Usually, the coupon rate is calculated by dividing the sum of coupon payments by the face value of a bond.

Bonds generally are priced at an initial face value (sometimes called “par” value) of $1,000 per bond. However, once the bond is traded on secondary markets, the bond’s price may be lower than the face value, which is referred to as a “discount,” or higher than the face value, which is referred to as a “premium.” Bonds with a fixed coupon (i.e. defined cashflow) will trade at a price either above or below par. The market process based upon current interest rates, credit risk and maturity date will determine if the defined cashflow is valued over par (premium) or below par (discount). This is typically completed by comparing the existing bond (previously issued) compared to the new issue bonds (primary offering). Bond prices typically have an inverse relationship with bond interest yields (e.g., as bond prices decrease, interest yields increase; as bond prices increase, interest yields decrease).

Unlike equities, where prices are usually evaluated based on their daily closing prices, many bonds do not have a uniform closing price because they are traded in over-the-counter (OTC) markets or another negotiated market. Bond prices are affected by many different factors, including but not limited to, supply and demand for the bond, the issuer’s credit rating, bond size, interest rates, and age-to-maturity. With regard to the age-to-maturity pricing factor, bonds are paid in full (at face value) when they mature, though some bonds are structured to give the issuer the ability to redeem them prior to the stated maturity date. Since a bondholder is closer to receiving the full-face value as the maturity date approaches, the bond’s price moves toward par as the bond ages. Many bonds are priced by discounting the expected cash flow to the present using a discount rate. This is called the Time Value of Money and Bond Valuation.

Fees and Costs

You will typically pay a “markup” as a transaction cost to the Firm when you buy a bond, as most bonds are traded on a principal (dealer) basis in the OTC market, although some bonds may be bought on an agency (commission) basis. With most bonds, instead of charging you a commission to perform the transaction for you, the broker-dealer marks up the price of the bond. The markup thus represents the difference between the price a broker-dealer pays for a bond and the price at which it is sold to you by the broker-dealer.

With new issues of bonds, the broker-dealer’s markup generally is included in the par value, so you do not pay separate transaction costs. Everyone who buys a new issue pays the same price, known as the offering price. If you are interested in a new issue of a bond, your financial advisor can assist you in obtaining an offering document describing the bond’s features and risks.

If you sell a bond before it matures, you may receive more or less than the par value of the bond. Either way, the clearing firm will mark down the price of your bond, paying you slightly less than its current value (and will then mark up the price slightly upon resale to another investor). This is how broker-dealers are compensated for maintaining an active secondary market.

The amount of a markup/markdown charged on a bond transaction will depend on a number of factors and particular circumstances for each transaction, including the type of bond (corporate, government, or municipal), transaction size, credit quality, unit price, maturity, liquidity, and market scarcity. BFE will charge a maximum of 1% of the trade price on markdown (sell) transactions and 2.25% of the trade price on markup (buy) transactions.

• For example, if you purchase 100 corporate bonds priced at 103.25 per bond and the markup is $22.50 per bond, you would pay $101,000 for the market price of the bond and then an additional $2,250 markup, which means you would pay $103,250 in total to purchase the corporate bonds.

More Information

Information about our bond markups and markdowns is available on our Fixed Income Transaction Fee Schedule.

More information about bonds is also available on FINRA’s Bond Resource Page for investors and on the Municipal Securities Rulemaking Board’s website (emma.msrb.org).