In this chapter, we are going to go over coupon, yield, price, maturity, ratings, and a couple of other items you will see whenever a bond is offered or available for sale.
Let’s assume you are being offered this bond for sale:
Security Description: “CALIFORNIA ST GO BDS”. Security descriptions are never as clean as they should be. The bond market is not that consumer friendly.
Descriptions can be intimidating and have a lot of acronyms. Anytime it says GO in the description in means General Obligation. If it is a town, it will have the town’s name along with any characteristics associated with the bond. There are hundreds of abbreviations. You want to make sure that you understand the security description fully spelled out with all of its implications. If it says “Taxable” in the description, it means that it is taxable. If you are not sure, ASK!
CUSIP: This is a 9-character number’ that is known as the CUSIP number. It is the equivalent of a stock ticker symbol. It is specific to a particular bond with a particular coupon and maturity date. When you are communicating about a bond or looking to exchange information related to a bond, your primary point of reference should be the CUSIP number.
Once you understand the security description, meaning you understand who the issuer is and what type of bond it is, you should pay attention to the other details:
Maturity Date: March 1, 2017
Coupon is the amount of interest you will receive every six months. 10′ means $10,000 (a bond is technically $1,000.) On $10,000 worth of bonds, you will receive $250 every six months for a total of $500 annually. You will receive a $250 payment of March 1st every year and on September 1st (September 1 is 6 months away from March 1.)
Rating is generally noted with the Moody’s rating first, then the S&P rating, and then the Fitch rating. A1/A- means that Moody’s rates the bonds A1 and S&P rates the bonds A-. The slash separates the rating.
The price quoted here is 115.139. This means $1,151.39 per $1,000 or 115.139 cents on the dollar. It is much easier to think of price as cents-on-the-dollar; this means $1.15139 since it is 115 cents. Simply multiply 1.15139 times $10,000. This equals $11,513.90. This is how much the bond will cost you to buy.
If you buy this bond for $11,513.90, your yield-to-maturity will be 2.217%. This is your return on investment.
To complicate matters, you should know that yield-to-maturity is an estimate. It is based on a few things: 1) You hold the bonds to maturity; 2) the bonds do not default; 3) You reinvest each interest payment at the same yield-to-maturity. Don’t get too hung up on #3 it is basically assuming that your interest payments are going to be compounded at the same rate.
It is the way bond arithmetic computes yield-to-maturity and since all bonds are quoted the same way, it will give you an apples-to-apples comparison. Your risk or inability to reinvest your interest payments at the same yields in the future is known as “reinvestment risk”.
From now (April 2011) until March 1, 2017, you will have received the following interest payments:
September 1, 2011: $250
March 1, 2012: $250
September 1, 2012: $250
March 1, 2013: $250
September 1, 2013: $250
March 1, 2014: $250
September 1, 2014: $250
March 1, 2015: $250
September 1, 2015: $250
March 1, 2016: $250
September 1, 2016: $250
March 1, 2017: $250
March 1, 2017: $10,000 return of the bond’s principal
Total Interest: $3,000
If you hold the bonds to maturity, you will have received a total of $13,000 including interest and principal. At a price of 115.139 today, you will pay $11,513.39 for the bonds today.
Plus, accrued interest.