When a large company or government borrows money, it usually does so through financial markets. The company or government issues securities that are generically called debt securities, or bonds. Debt securities represent a contractual obligation of the issuer to the holder of the debt security. Companies and governments may have more than one issue of debt securities (bonds). Each of these bond issues has different features attached to it, which affect the bond’s expected return, risk, and value.

A bond is governed by a legal contract between the bond issuer and the bondholders. Th e legal contract is sometimes referred to as the bond indenture or offering circular. In the event that the issuer does not meet the contractual obligations and make the promised payments, the bondholders typically have legal recourse. Th e legal contract describes the key features of the bond.

A typical bond includes the following three features: par value (also called principal value or face value), coupon rate, and maturity date. These features define the promised cash flows of the bond and the timing of these flows.

Par value – Th e par (principal) value is the amount that will be paid by the issuer to the bondholders at maturity to retire the bonds.

Coupon rate – Th e coupon rate is the promised interest rate on the bond.

Th e term “coupon rate” is used because, historically, bonds were printed with coupons attached. Th ere was one coupon for each date an interest payment was owed, and each coupon indicated the amount owed (coupon payment). Bondholders cut (clipped) the coupons off the bond and submitted them to the issuer for payment. The use of the term “coupon rate” helps prevent confusion between the interest rate promised by the bond issuer and interest rates in the market.

Coupon payments are linked to the bond’s par value and the bond’s coupon rate. The annual interest owed to bondholders is calculated by multiplying the bond’s coupon rate by its par value. For example, if a bond’s coupon rate is 6% and its par value is £100, the coupon payment will be £6. Many bonds, such as government bonds issued by the US or UK governments, make coupon payments on a semiannual basis. Therefore, the amount of annual interest is halved and paid as two coupon payments, payable every six months. Taking the previous example, bondholders would receive two coupon payments of £3. Coupon payments may also be paid annually, quarterly, or monthly. The bond contract will specify the frequency and timing of payments.

Maturity date – Debt securities are issued over a wide range of maturities, from as short as one day to as long as 100 years or more. In fact, some bonds are perpetual, with no pre-specified maturity date at all. But it is rare for new bond issues to have a maturity of longer than 30 years. The life of the bond ends on its maturity date, assuming that all promised payments have been made.

Example 1 describes the interaction of the three main features of a bond and shows the payments that the bond issuer will make to a bondholder over the life of the bond.

EXAMPLE 1. MAIN FEATURES OF A BOND

A bond has a par value of £100, a coupon rate of 6% (paid annually), and a maturity date of three years. These characteristics mean the investor receives a coupon payment of £6 for each of the three years it is held. At the end of the three years, the investor receives back the £100 par value of the bond.

Other features. Other features may be included in the bond contract to make it more attractive to bondholders. For instance, to protect bondholders’ interests, it is common for the bond contract to contain covenants, which are legal agreements that describe actions the issuer must perform or is prohibited from performing. A bond may also give the bondholder the right, but not the obligation, to take certain actions.

Bonds may also contain features that make them more attractive to the issuer. These include giving the issuer the right, but not the obligation, to take certain actions. Rights of bondholders and issuers are discussed further in the Bonds with Embedded Provisions section.