Cognitive basics of bonds

Abstract

Bonds are financial investments that are long-term debt investments in which the issuer (governments and businesses) commits to pay a series of periodic interest payments in addition to returning the principal amount (the face value of the bond) at the maturity date. Most corporate bonds have the following characteristics: maturity date ranging from 10-30 years, face value of the bond is $1000, and the annual interest payments equal the coupon interest rate or the nominal interest rate of the bond multiplied by its face value.

The bond's present value, its true value, is calculated by discounting its cash flows, which are the paid interests added to the principal value, at an appropriate discount rate. The true value of the bond (market value) fluctuates in response to changes in the required yield rates by investors. The required yield rate or discount rate for bonds includes the risk-free rate of return plus a risk premium. Interest rate risk arises from future interest rate increases, causing bond prices to decrease. Interest on bonds is paid either annually or semi-annually, and the relationship between market interest rates and bond prices is essential for valuation purposes, as the firm's value equals the market value of stocks and bond market value. The bond market has not experienced a recovery like the stock market. Still, since the early 1970s, the bond market in the United States and the international bond market in Europe have grown, with bonds attracting relatively significant interest in investment portfolios.