Bond Education – Cutting Through the Jargon
Every investment type has its own language, and fixed income is no exception. While investment professionals use these terms daily, the jargon can make it harder for investors to gain a clear understanding of the asset class. To help you gain a better feel for the bond universe, here are some of the most common terms used in fixed income investing. To help you build a more complete picture of bond investing, we have included links to other articles in this series where the terms are used.
Bonds and fixed income: are they the same?
Yes. Generally, fixed income and bonds both refer to a loan made by a government or company that pays a set level of interest throughout its lifetime.
Glossary of Key Terms
A bond is a loan agreement made between an issuer (such as a government or company) and a lender (the investor).
The coupon is the fixed interest (or income) a bond pays to the investor at regular intervals throughout the bond's life – quarterly, semi-annually, or annually. This regular payment structure is what defines fixed income. This differs from equities, where investors may receive dividends, but these are paid at the company's discretion and are not legal obligations.
Covenant
This is a legal agreement between the bondholder and the bond issuer. It outlines the requirements an issuer must meet during the bond's lifetime. At its simplest, a covenant requires the issuer to pay the coupon and repay the principal and is enforceable by law.
Every bond carries the risk that its issuer will fail to repay the loan in full at the bond’s maturity date. If this happens, it is known as a default. It’s worth noting that if a business fails, bondholders receive priority for payment over the company’s shareholders, which may allow bondholders to recover some capital, depending on the issuer’s financial situation.
When interest rates rise, bond prices usually fall, and vice versa. Duration measures a bond’s sensitivity to these changes in interest rates.
The duration of a bond portfolio can also change over time as bonds in the portfolio mature or as interest rates move.
This is the amount the issuer is obligated to repay to investors upon the bond's maturity, assuming no default.
Investment grade corporate bonds
Investment-grade corporate bonds are issued by robust, often well-known companies with strong credit ratings, suggesting a lower risk of default.
The entity that wants to borrow money by issuing the bond, e.g. governments, companies, or government agencies.
Also known as speculative or high yield bonds, these are issued by companies with lower credit quality and higher default risk than investment-grade firms.
The date when the bond ends and the issuer pays back the principal (the original loan amount).
Bonds are assigned credit ratings by independent rating agencies, such as Moody’s and Standard & Poor’s. The credit rating tells an investor how probable it is that an issuer will repay the coupon and principal on time. If a bond’s credit rating is downgraded, it becomes less attractive, and its price may decline.
The spread is the difference in yield between two bonds, usually reflecting the additional return an investor can earn for taking on more risk. For example, if a government bond pays a 5% coupon and a corporate bond pays 7%, the spread is two percentage points. Spreads are often used to compare bonds of similar maturity but different credit quality and are a key indicator of market sentiment.
Yield represents the actual amount an investor receives for lending their money. While the coupon rate is the fixed interest rate set at issuance, the yield fluctuates depending on how the bond’s market price changes. When a bond’s price rises, the yield declines (since you pay more for the same coupon). Conversely, if you buy a bond below its face value, your effective yield is higher.
Yield to maturity (YTM)
The yield to maturity represents the total estimated annual return an investor should receive by purchasing a bond at its present market value and holding it until the maturity date. Because it provides a comprehensive view of a bond’s potential return, it is a useful measure for comparing different bonds.
The yield curve is a graphical representation of the relationship between a bond’s yield to maturity and its time to maturity. It typically plots the yields of bonds that share the same credit rating but have different maturity dates. The shape of the yield curve provides insight into market expectations for future interest rates. For example, an upward slope indicates that market participants believe rates are likely to go up. Because the slope reflects investor sentiment about future rates, it serves as a useful indicator of the broader economic outlook.
