HISTORIA DE ITIL

There are certain terms and concepts that are critical for all bond investors to understand. This is particularly true because bonds, unlike stocks, are con- tractual relationships. And it’s helpful to know all the terms of a contract be- fore signing on the dotted line. Yet the problem is, the language associated with fixed-income instruments isn’t as intuitive as the jargon of equity investing.

For example, we can all appreciate concepts such as price and earnings and market value when it comes to stocks. But bond terms can be downright confusing. To learn more about the basics of bonds you can go to the Web site of the Bond Market Association, www.investinginbonds.com. There, you will not only find tutorials on what bonds are and how they work, there is also an extensive glossary of bond-related terms. The www.investopedia.com can also come in handy if you’re confused about what a certain fixed-income-related term means. We’ll tackle a few of them below.

PAR VALUE

This simply refers to the face value of each bond. Since bonds are typically sold in $1,000 increments, chances are thepar valueof your individual bond is going to be $1,000. One exception might be with municipal bonds, where par might be set at $5,000 per bond.

When you seek your principal back at maturity, this is the amount you will likely get back, per individual bond, at redemption. Par value is not to be confused, though, with your principal investment, though the two could be the same amount. If you purchased anewly issuedbond—one that a corpo- ration or government just auctioned off to raise money—you may very well have bought it for par value, in which case your principal investment and par value would the same: $1,000 per bond.

But remember that bonds can also be bought and sold in the secondary market, just like stocks, where older bonds can get passed around to new investors. (The same thing happens with other loans; for instance, even though you as a consumer may initiate a loan with your local bank for a home mortgage or even student loans, there is a good chance that your bank may resell that debt to another lending institution if it thinks it can get better terms by selling the paper than by hanging on to it.) If you purchased an older bond at a premium to par value—say you bought it for $1,100—then your principal would be $1,100 but par would still be $1,000.

MATURITY

This refers to the date at which the bond issuer agrees to redeem the bondholder. This is also the date at which the loan contract itself—the bond—expires, so interest payments and other benefits would also end at this time. It’s important to note, however, that some bonds may be called prior to maturity. Within the bond universe, some bonds are callable and others arenoncallable. A callable bond simply gives the bond issuer the right, under certain circumstances, to end the life of the contract sooner than expected.

Typically, the period before a callable bond can be called back by the issuer is referred to as thedeferment period, during which time the bondholder enjoys call protection. But after the deferment period ends, all bets are off. Some callable bonds come withcall premium, which means in the event that a bond is redeemed prematurely, the bond issuer agrees to pay the bondholder a slight premium above par to compensate him or her for the trouble.

PRICE

Like stocks, bonds come with a price. And that price can fluctuate throughout the trading day, depending on the level of demand for the fixed-income se- curity. But there are major differences in the way bond and stock prices are

listed. Indeed, while stock prices are fairly self-explanatory—a share listed for $20.50 sells for twenty dollars and fifty cents—it’s not so simple to figure out the price of a bond.

For example, all new bonds auctioned off by the issuer are sold at a preset price—par value. So if you were to purchase a new Treasury bond at auction, you would pay $1,000 per bond. If the price of that bond falls below $1,000 in the secondary market, it is said to be trading at adiscount. If it fetches a price that is above par value due to strong demand for the debt, than it trades at a premium.

There is a quirk, however, in the way bond prices are listed in newspaper tables and Web sites. Instead of listing the price of a bond trading at par value as $1,000, its price will be quoted as ‘‘100.’’ Bonds trading at a discount would be listed below 100—for instance, 99.75. Bonds trading at a premium would have prices above 100—for example, 101.25.

More important, bond prices, unlike stocks, are not in decimals, even though the prices as shown look as if they are. Treasury bonds, for instance, are quoted not as fractions of 100ths, but rather as fractions of 32nds. In other words, the price of a Treasury does not move in increments of pennies, but in increments of 1/32nds of a $1, or 2/32nds of a $1, etc.

So let’s say you’re considering investing in a two-year Treasury note whose price is listed as 105.11 (sometimes, you will see that same price listed with a colon, as in, 105:11). This doesnotmean that the bond is trading for $1,051.10, even though that would be the logical conclusion. Instead, it means the bond is trading for $1,053.44. How do we figure that? We arrive at this by first dividing 11—the figure after the decimal or colon—by 32. Eleven divided by 32 is 0.34375. This is interpreted in bond prices to mean $3.4375, which we can round up to $3.44. Now, we add that to $1,050 (which is how we interpret the 105 price before the decimal or colon) and get $1,053.44.

To confuse matters even further, many corporate issues trade not in 32nds, but in increments of eighths. This means prices can tick up or down in as small as 1/8th fractions. So if a corporate bond is listed at a price of 905⁄8, it is trading for $906.25. How did we figure that? We arrived at this figure by first dividing 5 by 8, which is 0.625. Because bond par values are in $1000s instead of $100s, we move the decimal and interpret it as $6.25. We add that to $900 (which is how we read the 90 price listed before the 5/8), and we get $906.25.

As if that weren’t confusing enough, like stocks, bonds have two prices: the bid and the ask. The bid price, again, is the price at which a bond buyer is willing to purchase a bond, while the ask is the price at which an existing bondholder is willing to unload his or her fixed-income security.