A bond looks like a simple promise: lend $1,000, collect interest, get the $1,000 back. Exam questions test how that promise bends: what backs it, what rates do to its price, who can end it early and how it is taxed.
When a corporation borrows from investors rather than a bank, it issues bonds. A bond is a debt security: the issuer promises interest on a schedule and repayment on a set date. Every bond states three terms:
- Par value: The face amount repaid at maturity, usually $1,000. Prices are quoted as a percentage of par, so 98 means $980 and 102 means $1,020.
- Coupon: The fixed annual interest rate, always applied to par. A 6% coupon pays $60 a year, usually as two $30 semiannual payments, whatever the market price.
- Maturity: The date the issuer repays par and the debt ends.
A bond priced below par is a discount bond. One priced above par is a premium bond.
Accrued interest. The issuer pays a full six months' coupon to the holder of record on the record date before each payment date.
Common mistakes
- Coupon applied to price: A 6% bond priced at $900 still pays $60, not $54; only the current yield moves.
- Ratio from market price: $1,080 ÷ $40 = 27 shares is wrong; the ratio uses par, so it is 25.
- Reversed yield order: On a discount bond the YTC is the highest yield, not the lowest.
Bottom line
- Par is $1,000 and the coupon is fixed dollars on par; in liquidation, secured bonds come first, then debentures, subordinated debentures, preferred and common stock.
- Prices and yields move inversely; long maturities and low coupons swing most, only the issuer calls, callable bonds pay more and their prices are capped near the call price.
- Current yield is annual interest divided by price; a premium bond ranks nominal > current > YTM > YTC, a discount bond reverses it, and yield to worst is the lowest.
- Investment grade is Baa3 or BBB- and above by market convention; a downgrade lowers price and raises yield.
Exam shortcut
Start every yield question by asking one thing: premium or discount? Write the four yields in order before reading the choices, then pick the lower of YTM and YTC for yield to worst. For a convertible, build the ratio from par, never market price, and compare stock price × ratio with the bond's price. A bond below that number means buy the bond and short the stock.
The full lesson (about 4,699 words, 31 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- C20
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