Accounting for Investments, Volume 2: Fixed Income Securities and Interest Rate Derivatives—A Practitioner's Guide

BASICS OF THE BOND MARKET

Types of issues and special characteristics

Various governments issue government bonds in their own currency and sovereign bonds in foreign currencies. Local governments issue municipal bonds to finance their projects. Corporate entities also issue bonds or borrow money from a bank or from the public.

The term “fixed income security” is also applied to an investment in a bond that generates a fixed income on such investment. Fixed income securities can be distinguished from variable return securities such as stocks where there is no assurance about any fixed income from such investments. For any corporate entity to grow as a business, it must often raise money to finance the project, fund an acquisition, buy equipment or land or invest in new product development. Investors will invest in a corporate entity only if they have the confidence that they will be given something in return commensurate with the risk profile of the company.

Bond coupon

The coupon or coupon rate of a bond is the amount of interest paid per year expressed as a percentage of the face value of the bond. It is the stated interest rate that a bond issuer will pay to a bond holder.

For example, if an investor holds $100,000 nominal of a 5 percent bond then the investor will receive $5,000 in interest each year, or the same amount in two installments of $2,500 each if interest is payable on a half-yearly basis.

The word “coupon” indicates that bonds were historically issued as bearer certificates, ...