The average fixed-income fund gained 6.7% in 2003. The top-rated Fidelity Advisor High Income Advantage bond fund returned an impressive 42.3% by comparison.

What is a Bond?

A bond represents a loan obligation of the bond issuer (government, corporation, or individual) to the bondholder or investor. In essence, the investor loans funds to the bond issuer in exchange for interest payments for a set period of time. At the end of this time the borrower (bond issuer) pays the investor (bond holder/loaner) back the money loaned. A certificate of deposit is an example of a bond. A consumer goes to the bank and gives the bank money. In turn, the bank pays the consumer interest for the use of that money for a specified period. Then, the bank uses that money to invest in other projects, such as, small businesses or home mortgages.

Bond Terminology

Face value or par value is the value of the bond (amount of principal) printed on the certificate and received at maturity. If interest rates change and you need to sell Bond A before maturity, the value you receive may change. If interest rates increase, Bond A may sell at a discount or less than the face value. In this case, investors can buy Bond B paying higher rates so they are not as interested in this Bond A. If interest rates decrease, Bond A may sell at a premium because other investors would be willing to pay more for the higher interest rate on Bond A. See the example on page 5 of this fact sheet.

Coupon Rate (also known as coupon, coupon yield, stated interest rate) is the interest rate printed on the bond certificate when the bond is issued. It usually is stated as an annual fixed rate typically paid every six months to the investor.

Maturity date is the day when the face amount of the bond must be repaid and the debt retired. The coupon rate remains the same until the maturity date. Bond maturities may run from a few months to 40 years.

A call feature allows the issuing agency to pay the investor the face amount for the bond and buy back the bond before maturity. This allows the issuer to then reissue the bond at lower interest rates. In the event a bond is called, investors may then need to reinvest their money at lower interest rates as well. This results in reinvestment rate risk.

Default is the failure of the issuer of the bond to make payment on the interest or money borrowed. Thus, the investor can lose money.

Tax-equivalent yield—If you are buying municipal bonds for the state in which you live, the interest may be free of federal, state, and local income taxes. (You still may have to pay capital gain taxes if you sell the bonds at a premium.) These income tax-exempt bonds are appropriate for investors with marginal tax rates of 28% or higher. There are charts that compare taxable and tax-free yields for different marginal tax rates. Refer to the following web site: for this type of chart.


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