Bond terminology uses phrases such as par, issue and spread to convey important facts about bonds. Each phrase may employ different shades of meaning depending on the context. Many terms in bond trading refer to coupon, maturity and call feature, terms which describe mathematical functions for computing the price and yield of a bond. Par, issue and spread are more commonly used to describe the size, price and relative value of a bond issue.
All bonds can be described in relationship to their maturity, or par, value. Bonds trade in points, with 100 referred to as maturity value. Bonds may be bought at a discount to the par value, meaning the bond's yield is a function of both the coupon, or interest payment date, and the difference between the discount and par. Premium bonds refer to bonds with an interest rate payment, or coupon rate, in excess of prevailing interest rates. The bond price thus trades above par, and the loss of the premium amount at maturity is made up by the extra coupon income.
When publicly traded bonds come to market it is usually with a syndicate, or group of underwriters, who agree to buy the entire issue at a certain maturity schedule, maturity value and price. This is called a new issue bond sale. After the sale of bonds, individual securities trade in an over-the-counter market, a market with rules of operation but not directed by any particular exchange. This market is called the secondary market. Bonds often trade on their par amounts, meaning a purchase of bonds refers to the maturity value of the bonds, not the current market value.
Bond issuance refers to whether a bond issue is trading in the new issue or secondary market. The issue price refers to the actual price of the bond, in points, not the maturity value of the bond. New issue bonds at the time of a bond sale may not have a firm date for settling with bond buyers. As a result, the bond yield but not issue price of the bond is known. The bonds trade at an indeterminate price called the new-issue price. Issue prices do not include accrued, or earned but not yet paid, interest. Interest is only paid on the coupon, or interest payment date, of a bond. This is usually a semiannual payment.
Spread refers not to the absolute interest rate but to the relative interest rate difference between a bond and a bond index, a treasury security of the same or similar maturity, or another bond of a similar or different credit. Spread relationships are constantly changing. Bond professionals use historical spread relationships to consider whether a particular bond is expensive or cheap relative to its historical spreads. Spreads tend to compress during periods of a strong business cycle and high interest rates. Spread relationships expand when rates are lower due to weak business fundamentals and credit risk concerns rise. A 10-year bond with an 8 percent yield and a 20-year bond with a 10 percent yield has a net spread of 10 minus 8 or 2 percent.
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