16 Bond Market Terms Every Trader Should Know

Most traders are familiar with stock market terminology, but trading the bond market can be just as lucrative. Unfortunately, the bond market comes with its own set of terminology, and trading bonds successfully requires traders to understand at least the basics of bond market lingo.

The following are 16 bond market terms that every trader should know.

1. Issuer: A bond’s issuer is the entity that creates the bond, sells it and is responsible for paying it back with interest. Federal and local governments and corporations are the most common bond issuers.
2. Par Value: The par value of a bond is essentially the face value of the bond. When thinking of a bond as a loan, the par value is the principal of the loan that must be paid back when the bond matures.
3. Price: Price is subtly different in the bond market than par value. Issuers often must sell bonds at a price discount to par value in order to entice a buyer to invest.
4. Discount: A bond trading at a price below its par value is said to be a trading at a discount.
5. Premium: A bond trading at a price above its par value is said to be trading at a premium.
6. Maturity: Maturity is the length of time until the bondholder is due to receive the par value of the bond. Bonds can have maturities ranging from a matter of weeks to more than 10 years.
7. Coupon Rate: The coupon rate is the interest rate that the issuer promises to pay to the bondholder. Bonds can have floating or fixed coupon rates. Most bonds pay interest semiannually, but some make monthly or annual payments.
8. Current Yield: Current yield is a measure of the interest rate a bond is currently paying relative to its price, not its par value. The current yield is the actual yield that buyers will receive on their investment if they purchase a bond priced at a premium or discount to par.
9. Basis Point: Because bond yields typically fluctuate very little on a daily basis, bond traders often discuss yields in terms of basis points. One basis point equals one one-hundredth of a percent, or 0.01 percent. If a bond yield increased from 2.25 percent to 2.3 percent, that would be a 5-basis point increase.
10. Yield To Maturity: Yield to maturity is a more complicated calculation than current yield that assumes a bond buyer will be holding the bond until maturity. Yield to maturity factors in additional interest that can be earned if annual or semiannual interest payments are reinvested at the yield to maturity rate.
11. Callable Bond: Some bonds have call provisions allowing the issuer to redeem the bonds at a specified price on a specified date or dates prior to their scheduled maturity date. Issuers will choose to exercise their call provision when market interest rates fall well below the coupon rate of a callable bond.
12. Yield To Call: A callable bond will have a yield to call, which indicates a bond’s theoretical yield if the issuer decides to exercise its call provision prior to maturation.
13. Yield To Worst: If a bond has multiple call dates prior to maturity, yield to worst is the lowest possible yield to call among the call dates. In other words, yield to worst is the worst yield a bondholder could possibly receive, assuming the issuer calls the bond at some point prior to maturity.
14. Zero Coupon Bonds: Instead of making regular interest payments throughout the duration of the bond, zero coupon bonds accumulate all their interest and pay the bondholder one lump-sum payment at the maturity date. As a result, zero coupon bonds typically sell at a significant discount to par value.
15. Convertible Bonds: Convertible bonds are a special class of bonds that can be redeemed for shares of a company’s stock at a specified exchange rate. Because convertible bonds offer investors more potential upside if the issuer’s stock price rises, they typically have lower yields than non-convertible bonds.
16. Fed Funds Rate: The fed funds rate is an interest rate established by the Federal Reserve that sets the interest rate financial institutions much pay each other for overnight loans. Most bond rates are not directly tied to the fed funds rate, but many bond prices are negatively correlated with the fed funds rate.

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U.S. Treasury photo via Wikimedia.