Securities For Beginners

Monday, January 30, 2006

Bond types explained (Overview)

Convertible Bonds:

Convertible Bonds are corporate bonds that can be converted into common stock of the issuing company. As a result, convertible bonds are usually offered with a lower yield. Investors may like convertible bonds because of the mixture of a bond's constant income stream combined with the chance to participate in a rising share price. On the other hand, there's always the chance that the share price takes a downturn and the bond's holder is stuck with the low coupon rate, because it's unattractive to convert the bond into shares.

Zero-Coupon Bonds:

Zero-Coupon bonds come with no interest rates to be paid by the company. Sounds strange? Well, here's the clue: They're sold with a considerable discount to par value, but in the end the whole par value is paid to the bond owner.

Coupon: 0
Par Value: $1000
Years to maturity: 5
Bond's price: $800
In this example you pay $800 now and will receive $1000 in five years, but won't receive any interest payments in the meantime.

Callable Bonds:

Issuing callable bonds allows the company to redeem the bonds before maturity. In return a premium is paid to the bond holders when the company uses the call option to compensate the future interesting rates that won't be paid due to the call. The call option is often used when interest rates decline and therefore the company has the opportunity to restructure its debts to better (i.e. "cheaper") conditions.

Bonds with floating interest rates:

Some bonds come with flexible interest rates. The actual interest rate paid by the issuer depends on some index, for example the short-term Treasury bills or the EURIBOR in Europe. Usually the prices of normal bonds decline when market interest rates raise, but due to the constant adjustment of the interest rates the volatiliy of bonds with floating interest rates is lower compared to normal bonds.

Related Post: on Bonds


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