BOND BASICS

A bond is issued with a stated value, known as the par, or face, value. This is the value at which the bond will be bought back by the issuer upon its maturity. Though there are exceptions to the rule, most bonds are issued with a $1,000 par value. While a bond's current value can and usually does fluctuate during its lifetime, this par value remains fixed. At issue, most bonds also offer a fixed interest rate, or coupon rate. This is the annual rate of interest, calculated as a percentage of par, that the holder of the bond will earn. For example, if a $1,000 par value bond has a 5 percent coupon rate, each year the holder of that bond will earn 5 percent of $1,000, or $50 (5% x $1,000 = $50).

There are several yields with which bond investors must be familiar, but the most important is the yield-to-maturity, or YTM. This is the total return an investor receives from a bond, based on the annual interest rate and any profit or loss realized on the sale of the bond. Simply put, YTM is the yield calculation used to compare the value of bonds with different issue and maturity dates, coupon rates, and par values.

Another important bond concept is present value -- the assumption that, due to inflation, a specified sum of money received today will be worth more than the same amount received at some point in the future. Because bonds are based on the foundation of "payments over time," investors should be aware of this relationship between the values of money received today and the same amount received later.