If you want to invest in securities while preserving your capital, the fixed income market or bond market is one of the best options for you. It is also known as the debt securities market, and enables corporations and governments to raise capital for business and public service purposes.
But for those new to the fixed income market, and even for long-time investors, bond trading can be a bit confusing. In many ways, trading bonds is the same as trading stocks or mutual funds. However, some details related to fixed income assets make bond trading processes unique.
Critical Bond Trading Terms You Should Know
All bond trades share a common vocabulary. Below are essential terms you should know.
1. Trade Date vs. Settlement Date
In bond trading, the trade date refers to the date on which the bond buyer and seller enter into a purchase agreement that defines the bond, its price and quantity, and delivery terms. It marks the beginning of the transaction.
On the other hand, the bond settlement date refers to the date on which the securities will be delivered to you as the buyer and money will be exchanged for the shares you receive. During this date, there is a transfer of ownership, which helps to complete the bond settlement process or transaction.
Concerning the bond settlement date vs. maturity date, the former refers to when the transaction is complete and the bond is given to the investor after they lend the issuer money. And the latter refers to when the bond matures and the issuer has to pay back the money it owes the investor.
2. Face Value vs. Principal
The face value of a bond is also known as the par value. It refers to the amount that you will get as the bondholder when the bond matures, so long as the bond issuer does not default. And the static value is set within the contract when the bond is issued the first time.
The interest rates associated with a bond are usually pegged on its face value and are expressed in the form of percentage. They are usually referred to as coupon rates. Any bond that sells above par value is selling at a premium, while one that sells below par value is selling at a discount.
The principal also refers to actual initial investment to buy the bond. If you hold your bond to maturity, then the principal will be equal to its par value. And the bond issuer has the obligation to pay you what was stipulated in the contract. So, the term can be used interchangeably with face value when referring to bonds.
Generally, most bonds trade "OTC," or over-the-counter, meaning that they trade through securities firms rather than a stock exchange.
Fixed Income Trade Settlement Process
Once you select a bond through your investment representative or online through a broker, you place a trade. The date you place the trade becomes the trade date, and determines the settlement date.
For most corporate bonds, the bond settlement process tends to take two business days. This two-day window is known as T+2. U.S. Treasury bonds and other government bills and options tend to settle one day after trade (T+1).
However, asset-backed bonds like Fannie Mae may settle several days later. On settlement date, your broker will wire money to the seller on your behalf and you will receive shares of the bond in return.
Primary and Secondary Market
Bonds are sold on the primary market and the secondary market. A primary market bond is a new bond that you buy directly from the issuer and the trade settles on the first date the bond is available, meaning that you may have several weeks between the trade date and settlement date. Secondary market bonds are purchased from other consumers who have owned the bonds for a period of time.
Bond Interest Payments
Bonds accrue interest on a daily basis and pay that interest periodically throughout the year – usually semi-annually. These payments are made to whoever owned the bond on the payment date, whether or not he held it for the entire period.
If you purchase a bond between interest payments, you will pay the seller the value of the accrued interest as part of the trade. This amount is paid back to you when you receive the full interest payment later in the year.
It is worth noting that the bond price may be adjusted up or down based on external market forces when it’s trading in the open market. When bond prices go down, the interest rates rise, and vice versa. So, that's something to think about.
- ScienceDirect: Fixed Income Market
- BlackRock: What is fixed income investing?
- IG: Bond trading definition
- AccountingTools: The difference between trade date and settlement date accounting
- Corporate Finance Institute: Settlement Date
- Strategic CFO: Par Value of Bonds
- Finance Strategists: What Is the Principal of a Bond?
- Investor.Gov: Settling Securities Transactions, T+2
- MunicipalBonds: Accrued Interest: Definition, Formula, and Example
Nola Moore is a writer and editor based in Los Angeles, Calif. She has more than 20 years of experience working in and writing about finance and small business. She has a Bachelor of Science in retail merchandising. Her clients include The Motley Fool, Proctor and Gamble and NYSE Euronext.