Debt Mutual Funds – Part 1

What is a Bond ?

A bond is a loan borrowed by a company or government to finance it’s operations

Par value or Face value : This is the principal amount that is borrowed

Coupon  : This is the interest rate that the company is obliged to pay it’s lender

Maturity : The time when the bond is matured. i.e at the end of maturity, the company pays back the principal and the accrued interest to the lender

E.g. A company needs $5 million to open a new unit. It will raise money by issuing 1000 bonds each having a face value of 5000$ with annual coupon 10% and maturity of 10 years.

Note : The coupon will be paid semi annually. i.e, From previous example, the company will be paying 250$ every 6 months and will return the principal 5000$ after 10 years.

These bonds are traded in bond market just like shares are bought and sold. The market price of the bonds depends on the prevailing interest rates on the market.

If the coupon rate is less than the prevailing market interest rates, then the bond prices goes up.

If the coupon rate is more than the prevailing market interest rates, then the bond price goes down.

E.g. We have a bond of company A with following details

Coupon rate – 5%, Face value 1000$, Maturity 5 years.

After 2 years, the interest rates went up to 6%. i.e, if you were to buy a new bond, it will come with a coupon rate of 6%.

In that case, the bond of company A which gives just 5% coupon seems unattractive and hence it’s market price goes down.

 

 

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