Bond Fundamentals and Pricing › Anatomy of a Bond
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A bond is a contractual agreement between an issuer (the borrower) and investors (the lenders). The issuer promises to make a series of payments according to a predetermined schedule in exchange for receiving capital upfront. The key parameters that define a bond are:
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Face Value (Par Value): The principal amount promised at maturity. A $1,000 face value is common in corporate-bond examples, but actual denominations vary. A price quoted as 100 means 100% of face value, not necessarily a $100 principal amount. The face value is the basis for calculating coupons.
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Coupon Rate: The annual interest rate applied to the face value to determine periodic payments. A 5% coupon on a $1,000 face value bond pays $50 per year in interest.
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Maturity Date: The date when the issuer must repay the face value. Maturities range from short-term (under 1 year) to long-term (30 years or more).
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Payment Frequency: How often coupon payments occur. Most bonds pay semiannually in the US, while European bonds often pay annually.
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Issuer: The entity borrowing money. Issuers include sovereign governments, municipalities, corporations, and supranational organizations.
A bond trades at par when its price equals its face value, at a premium when the price exceeds face value, and at a discount when the price is below face value. These relationships depend on how the bond's coupon rate compares to prevailing market interest rates.
Government vs. Corporate Bonds
US Treasuries and German Bunds are often used as low-credit-risk benchmarks in their respective currencies. That does not make them free of interest-rate, inflation, or liquidity risk, and a benchmark must match the currency and horizon of the valuation. Government payment capacity and institutional arrangements differ: Germany, for example, does not independently issue euros to service its debt.
Corporate issuers can default on their obligations. Investors generally require compensation for that risk relative to an appropriate low-credit-risk reference. A credit spread compares a bond's yield with a stated reference yield of comparable maturity; it can reflect default and recovery expectations as well as liquidity, risk premia, and other contractual features. It is not a direct estimate of default probability alone.