Lightyear offers a selection of corporate and government bonds trading on Nasdaq Baltic stock exchanges.
What are bonds
Bonds are debt securities issued by governments, corporations, or other entities to raise capital. When you invest in a bond, you're essentially lending money to the issuer in exchange for periodic interest payments (coupons) and the return of the bond’s face value at maturity.
Key characteristics of bonds include:
- Face value: the amount paid back to the bondholder at maturity
- Coupon rate: the fixed interest rate paid to the bondholder, usually semi-annually or annually
- Maturity date: when the bond's principal is repaid
- Yield: the bond's return, factoring in interest payments and price changes
- Credit risk: the risk that the issuer might default on payments
- Duration: sensitivity of a bond’s price to changes in interest rates
Bonds are traded on either the primary or secondary market. On the primary market, new bonds are issued directly by governments or corporations to investors. On the secondary market, bonds are bought and sold between investors after they’ve been issued. Bond prices can go up or down below the face value. Prices fluctuate here based on factors like interest rates, the issuer’s creditworthiness, and market demand.
Prices and yield
Bond price is the amount investors pay to purchase a bond in the market. A bond can trade at a premium (above face value), par (at face value), or a discount (below face value).
- The full or dirty price: the dirty price is the total price the buyer pays for the bond, which includes both the clean price and the accrued interest. This is the actual transaction price when buying a bond between coupon payment dates.
- Clean price: the clean price is the bond’s quoted price in the market, which excludes any accrued interest since the last coupon payment. It reflects only the bond’s intrinsic value without factoring in interest accumulation.
- Annual yield: this is the annual return on the bond based on its current market price, not its face value. It is calculated as the bond's annual coupon payment divided by the bond’s current market price. It gives a snapshot of a bond’s yield but does not account for price changes or time to maturity.
Bond prices and yields have an inverse relationship:
- When bond prices rise, the yield falls. This happens because the fixed coupon payments now represent a lower percentage of the bond’s higher price.
- When bond prices fall, the yield rises. This occurs when a bond’s price drops, making the fixed coupon payments a higher percentage of the lower price.
Coupon payments
Bond coupon payments are the periodic interest payments made to bondholders by the bond issuer. These payments are typically a fixed percentage of the bond's face value (also known as the par value), and they are made on a regular schedule, usually semi-annually or annually, until the bond matures. However, if a bond is sold before maturity, the bond price may fluctuate due to changes in interest rates or the issuer's creditworthiness, but the coupon payment amount stays the same.
- Coupon rate: the coupon rate is the annual interest rate that the bond issuer agrees to pay the bondholder. It is expressed as a percentage of the bond's face (par) value. For example, if a bond has a face value of €1,000 and a coupon rate of 5%, the issuer will pay €50 annually in coupon payments.
- Payment frequency: coupon payments are usually made semiannually (every six months), although they can also be paid annually, quarterly, or monthly. For example, if a bond pays €50 annually, and payments are made semiannually, the bondholder will receive €25 every six months.
- Maturity: the coupon payments continue until the bond reaches its maturity date, at which point the issuer repays the bond’s principal (face value) to the bondholder and coupon payments stop.
If I sell my bond before the coupon payment date, do I lose my accrued interest
No, if you sell your bond before the coupon payment date, you do not lose your accrued interest. Here's how it works:
- Interest accrues daily between coupon payment dates. The bond price you see in the Lightyear platform (dirty price) automatically includes the interest accrued since the last coupon payment.
- If you sell your bond before the next coupon payment, the trade price that the new bondholder (buyer) pays and what you (seller) receive for the trade includes the interest that has accrued since the last coupon payment.
- Therefore, you (seller) will receive the interest accrued since the previous coupon payment when the trade is executed. The new bondholder (buyer) will receive the full coupon payment on the next scheduled payment date.
Example:
- You own a bond with a €1,000 face value, paying 5% annual interest (semiannual coupon of €25).
- If you sell the bond halfway through the six-month period, the buyer will pay you the accrued interest for three months, which would be €12.50.
- On the next coupon payment date, the buyer receives the full €25 coupon payment.
In summary, you don't lose your accrued interest when selling a bond before the coupon payment date; the buyer compensates you for the interest earned.
Bond maturity
When a bond reaches its maturity date, the bondholder is repaid the bond’s face value (or principal), the bond’s issuer no longer has any further obligations to make interest (coupon) payments, and therefore the bond contract is considered complete. Here’s what typically happens:
- Final coupon payment: if the bond pays periodic interest (coupon payments), the bondholder will receive the final coupon payment on the maturity date. This is in addition to the return of the principal.
- Return of principal (face value): the issuer repays the bondholder the face value of the bond. For example, if the face value of the bond is €1,000, the bondholder will receive €1,000 on the maturity date.
- End of interest payments: once the bond matures, interest payments stop. The bondholder no longer earns interest beyond the maturity date.
It’s important to remember that some bonds are callable, meaning the issuer can repay the bond before the maturity date. If the bond is called, the bondholder will receive the face value earlier than expected. Additionally, if the issuer defaults (fails to make payments) before or at maturity, bondholders may not receive the full repayment of the principal or final coupon payment.
See also: Complex instruments