How bonds work
What a bond is: face value, coupon and maturity, Treasury bills, notes and bonds, and why the issuer pays whoever holds the bond on the day.
A loan cut into pieces
A bond is a loan, cut into pieces that can be bought and sold. The borrower, the issuer, promises fixed payments on fixed dates. Whoever holds a piece on the payment date gets paid. The issuer does not care who that is.
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A bank loan usually stays with the bank. A bond trades: the first buyer can sell it next week to a pension fund, which can sell it to a bank. The promise travels with the paper. That is why a bond has a market price, and why that price can change while the promise stays the same.
Face, coupon, maturity
Face value, or par, is the amount repaid at the end: $1,000 here. The coupon is the yearly interest as a share of face: 4% is $40 a year. Maturity is the day the face comes back. US notes pay the coupon in two halves, every six months.
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The word coupon is a leftover. Old paper bonds came with tear-off slips, one per payment, that the holder clipped and took to a bank to be paid. The slips are gone, and the name stuck.
Bills, notes and bonds
The US Treasury borrows at three lengths. Treasury bills run a year or less and pay no coupon: you pay face or less, and get face back. Treasury notes run 2 to 10 years and Treasury bonds 20 or 30, both with a coupon every six months.
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Count the cash
The note is a list of payments. Twenty coupons of $20 is $400, and the $1,000 face comes back with the last one. That is $1,400 in all, for about $1,000 paid today. Everything a bond is worth comes from that list.
Key terms
- Bond
- A loan cut into tradable pieces. The issuer owes fixed payments to whoever holds it.
- Face value (par)
- The amount repaid at maturity, $1,000 on a typical note. Prices are quoted per 100 of it.
- Coupon
- The yearly interest as a share of face. US notes and bonds pay it in two halves.
- Maturity
- The date the face value is repaid and the bond ends.
- Treasury bills, notes and bonds
- US government debt by length: bills a year or less (no coupon), notes 2 to 10 years, bonds 20 or 30 years.
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