Companies and governments borrow money by selling bonds. Investors who purchase a company’s bonds receive interest on the bond and are promised a return on their investment at a future date. The future date is when a bond matures. Bond variables -- such as interest, price and yield type -- in place at the time of purchase determine what occurs on the bond’s maturity date. Usually, the bond issuer repays the bond principal to the investor on the maturity date. However, the issuer and the bond purchaser can make alternative agreements.
The maturity date for a bond can be as far off as 30 or 100 years. Maturity dates for short-term bonds range up to three years. Medium-term bonds mature at ranges of four to 10 years. The maturity date range for long-term bonds exceeds 10 years. Short-term bonds have less risk, provide lower returns to investors and the principal investment amount is repaid sooner. Long-term bonds have greater risk for investors due to the greater risk of market fluctuations over a long period, but offer bond purchasers larger returns.
Bonds may have floating or fixed interest rates. Bond interest may also be payable at maturity. If you purchase a bond with fixed rate interest, you will receive coupon payments on the interest twice yearly until the maturity date, at which time you are paid the face value, or principal, of the bond. The interest changes periodically on floating rate bonds. Bond holders do not receive regular interest payments on zero coupon bonds, but instead receive one payment on the maturity date. The lump sum payment includes the principal, or purchase price, and the total interest earned on the bond based on the original interest rate. Zero coupon bonds are sold for significantly lower prices than the face value.
Bond issuers and purchasers choose from several redemption options for repayment of investment based on the maturity date. Some redemption options allow bond purchasers or issuers to change the bond’s maturity date. The call provision allows the bond issuer to redeem the bond before the maturity date, usually by simply paying off the face value. The put provision gives the bond buyer the right to sell the bond back to the issuer before the maturity date at a set price, which is usually the face value. Convertible bonds, which are corporate bonds, allow a bond purchaser to convert the bond into common stock in the company in lieu of a cash payment. Some bonds are designed to compensate investors, such as those who purchase mortgage-backed bonds, based on the average life of bonds instead of the listed maturity dates.
The bond yield refers to the return you earn on the bond and is based on the price you paid for the bond and the interest payments you receive. Current yield, which is calculated by dividing the interest payment by the purchase price, is the annual return you earn on the dollar amount you paid for the bond. Yield to maturity, which is the return you receive if you hold the bond until the bond matures, is based on the interest payments you have received, interest earned and loss and gain of principal. The yield to call return is offered to investors who agree to hold the bond until it is called or paid off by the issuer before the bond’s maturity date. Some yield to call bonds may be called at any time, while others are limited to specific dates or prohibited from calling during the first years after purchase.