Know Your Bond Terms

If you don't know an inverse yield curve from an accrued market discount, it's time for a little review session on bond terms.

Learning any language has its challenges. You might get hung up on that funny nasal sound in French, or the inability to click in Xhosa, the African language made famous by Miriam Makeba. In the same respect, the language of bond investing can be just as difficult to grasp, particularly if you don't have a financial background.

With the stock market in flux, you may be thinking about beefing up your bond positions. Before you make any big moves, however, take a minute to review your knowledge of bond vernacular.

• Coupon bond. A coupon bond, also called a bearer bond, is a security that entitles the holder to periodic interest payments. There's no owner's name printed on the bond itself, and the issuer keeps no record of the purchaser's name. The bond has interest certificates (or coupons) attached to it; the interest payments are made to the individual who removes the coupons and submits them to the issuer.
• Face value. Face value is the amount paid to a bondholder by a bond issuer at maturity. Since bonds are a form of debt for the issuer, the face value can be thought of as the amount borrowed from the investor. Face value is also called par value.
• Maturity. Maturity can be either the length of time before a debt must be repaid, or the exact date on which it must be repaid. A bond can be described as having a five-year maturity, for example, or as having an April 2013, maturity.
• Discount bond. Discount bonds are securities that are issued for an amount below their face value. Because they don't pay interest, the investor's yield comes from the difference between the purchase price, and the face value paid at maturity. The market value of a discount bond gradually moves towards the face value as the maturity date approaches.
• Accrued market discount. Accrued market discount is the positive change in a discount bond's market value, unrelated to interest rate changes, as the maturity date approaches. If an investor purchases a discount bond with a face value of $2,000 for $1,500 and holds it, that bond will pay the investor $2,000 at maturity. The $500 earned is the accrued market discount.
• Junk bond. A junk bond has a low credit rating, based on a high default risk as measured by bond rating agencies. Junk bonds must pay very high interest rates to compensate investors for the increased risk of loss that they carry. Other names for junk bonds include high-yield or speculative bonds.

After this quick review, you're ready to move on to more advanced bond topics. But don't worry...you won't have to learn any maddening conjugation rules-just some terms related to economics and interest rates.