Bond Basics: Issue Size & Date, Maturity Value, Coupon
Investors often add bonds to their investment portfolio to provide an element of stability, as bonds are known to be safe, conservative investments. When you invest in bonds, you're providing a steady stream of income in times when your stocks may perform poorly, and bonds are a great way to protect your savings when you don't want to put your assets at risk.
Six Key Bond Features
Most individual bonds have five features when they are issued: issue size, issue date, maturity date, maturity value, and coupon. Once bonds are issued the sixth feature appears—yield to maturity, which becomes the most important figure for estimating the total yield an investor will receive by the time the bond matures.
Issue Size and Date
The issue date is simply the date on which a bond is issued and begins to accrue interest. The issue size of a bond offering is the number of bonds issued multiplied by the face value.
For example, if an entity issues two million bonds with a $100 face value, the issue size is $200 million dollars. The issue size reflects both the borrowing needs of the entity issuing the bonds, as well as the market’s demand for the bond at a yield that’s acceptable to the issuer.
Maturity Date and Value
The maturity date is the date on which an investor can expect to have their principal repaid. It is possible to buy and sell a bond in the open market prior to its maturity date, which changes the amount of money the issuer will pay the holder of the bond based on the current market price of the bond.
Since bonds trade on the open market from their date of issuance until their maturity, their market value will typically be different than their maturity value. However, barring a default, investors can expect to receive the maturity value at the specified maturity date, even if the market value of the bond fluctuates during the course of its life.
Coupon and Yield to Maturity
The coupon rate is the periodic interest payment that the issuer makes during the life of the bond. For instance, if a bond with a $10,000 maturity value offers a coupon of 5%, the investor can expect to receive $500 each year until the bond matures. The term “coupon” comes from the days when investors would hold physical bond certificates with actual coupons that they would cut off and present for payment.
Since bonds trade on the open market, the actual yield an investor receives if they purchase a bond after its issue date (the yield to maturity) is different than the coupon rate.
Yield to maturity is a calculated estimate of the total amount of interest income a bond will yield over its lifetime. This is the value that most bond investors worry about.
Example of a Bond's Yield
Starting with the dollar amounts from the example above, suppose that a company issues 10-year bonds with a face value of $10,000 each and a coupon of 5% annually. In the two years following the issuance, the company experiences rising earnings, which adds cash to its balance sheet and provides it with a stronger financial position. All else equal, its bonds would rise in price, say to $10,500, and the yield would fall (since prices and yields move in opposite directions).
While the coupon would remain at 5% (meaning that investors would receive the same $500 payment each year), investors who purchased the bond after it had already risen in price might receive different yields to maturity (YTM), depending on the price they purchased the bond at.
Be cautious of online YTM calculators and easy formulas, as many of them are not accurate; many financial advisors also confuse YTM with a bond's current value. The formula for calculating yield to maturity uses the bond's coupon, face value, current price, and the number of years it takes to mature.
YTM = ( C + ((FV - PV) ÷ t)) ÷ ((FV + PV) ÷ 2)
- C—Interest/coupon payment
- FV—Face value of the security
- PV—Present value/price of the security
- t—How many years it takes the security to reach maturity
To calculate our bond's YTM:
=($500 + (($10,000 - $10,500) ÷ 10)) ÷ (($10,000+ $10,500) ÷ 2)
=($450) ÷ ($12,500)
=.036, or 3.6%