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I'm new to bonds and have some very basic questions. Let's say there is a bond distributed by company A. The par value is $100/bond with a coupon rate of 5.35% (semi-annual distribution). The maturity date is 20 years from now.

From what I understand, this means that, if I were to purchase one bond from company A right now, I would receive in interest $5.35 at the end of every year (or $2.675 every six months) for twenty years, at the end which company A will return my original $100. All of this is guaranteed unless company A defaults on this bond. That's why bonds are known as conservative investments (safe with lower yield).

Correct me if I"m wrong here.

I know bond prices fluctuate. If I were to buy a single bond of company A at 90% par value, I would still get the 5.35% coupon rate, meaning I purchased this bond for $90, and my annual interest is still $5.35. I know the yield rate is a bit higher because that takes into account my lower purchase price compared to par value.

My question here is if I were to hold this to maturity, will company A pay me back my principal at par value ($100) or what I actually paid for (90% par = $90)?

Second, let's assume my bond becomes less and less valuable. I bought it at par value, but now the market price is 10% par (or $10) because other bonds are much more attractive. Is my coupon rate guaranteed regardless (5.35%) and I will still get my $100 back at maturity? But if I were to sell before the maturity date then I would only receive $10 correct (or whatever prevailing price on the date I sell)?

P.s. If I bought a single bond for 100% par at $100, and the commission is listed as 0.75%, what does that 0.75% mean? 0.75% of what? The principal and/or interest?

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    You always get 100 back plus all coupon payments in your example (unless the company defaults). If the price were to drop to 10%, the likelyhood of default will be substantial which is why you can only sell it so "cheap". Commision is usually in % of the market price of the bond.
    – AKdemy
    Apr 14, 2023 at 9:56
  • Really? So if the par value was 100$, and I bought this bond when its market value is 10$ (obviously with a non-competitive yield rate by then), I would still get 100$ at maturity if I waited that long? But if I were to sell earlier I would only get 10$ right? Apr 14, 2023 at 11:14
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    Correct. If you buy or sell early you get the current price. Otherwise you get back the entire notional (100 in your example). However, before you start buying bonds that are that "cheap", remember that there is always default risk. No reasonably safe bond will ever drop that much. In case of default, you may not get back anything, not even the 10%>
    – AKdemy
    Apr 14, 2023 at 12:02
  • Market fluctuation due to interest rate risk is why I buy actual bonds (on the secondary market; we're much too small scale to buy them at issue), and then hold them until maturity. And I buy them in my IRA, since dividends are taxed. Note also that buying them below par creates capital gains at maturity. Another reason to buy them in an IRA.
    – RonJohn
    Apr 14, 2023 at 15:41
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    ‘Very basic questions about bond investing’ is an awful question title. Apr 15, 2023 at 13:43

2 Answers 2

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Most of the time when you buy a bond you're buying on the secondary market, that is, you buy from someone else who happens to own the bond you're interested in. The price on the secondary market is affected by prevailing interest rates; when interest rates go up, the value of existing bonds goes down and vice versa. But a bond is a contract. Trades on the secondary market don't affect its terms; it pays its coupon rate, and at maturity it pays the principal amount[1]. So, yes, if interest rates go up, the market value of the bond goes down, but it still pays all of its interest and, at maturity, it pays its face value[2].

[1] Some (many) bonds have more complex terms, but for basic understanding, begin with bonds that simply pay a fixed interest rate and a fixed term.

[2] If you bought it at a discount you have a taxable gain when the company pays you the principal.

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For a fixed-rate bond, you always get the coupon as a percentage of the face value of the bond. Unless the company defaults on the bond, you will get the same coupon amount each period and the face amount at maturity. Which makes sense if you think about the fact that the company has no idea what you (or anyone else) paid for the bond.

Yes there is a risk that the value of the bond goes down. Corporate bonds have two main risk factors: risk-free (government) interest rates and credit risk. As government interest rates go up, fixed-coupon bonds become less valuable, since you can now buy bonds with higher coupon rates (and you'd pay less for bonds with lower coupons).

The other factor is credit risk, or the risk of default. If the value of a corporate bond goes down in price significantly (relative to risk-free bonds), it means that the market thinks that there is a real chance that the company is going to default on the debt, and bond holders will get nothing (or a small percentage of the face value if the company liquidates and there is some money left over).

If a bond sells for 10%, it's roughly equivalent to the market thinking that there's a 90% chance that the company will default and bond holders will get nothing. The actual math is much more complicated, but that's the idea.

Commissions are always (in my experience) paid on the market price of a bond, so you'd pay that on what you pay for the bond (or sell it for), not the face value.

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    The 90% expectation of a default isn't right, and bonds often don't experience full losses in the event of default. Default risk is only one piece of bond pricing, and it doesn't impact price at the initial point of sale, just the coupon rate. Another is current interest rates. Rates rising after purchasing a bond will decrease the price.
    – Stan H
    Apr 14, 2023 at 14:56
  • I believed I covered all of those?
    – D Stanley
    Apr 14, 2023 at 15:24
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    I was just focusing on the "If a bond sells for 10%, it's roughly equivalent to the market thinking that there's a 90% chance that the company will default and bond holders will get nothing" part.
    – Stan H
    Apr 14, 2023 at 15:31
  • Fair enough - I was trying not to complicate it too much and just illustrate that a 10% value means an almost certain default. Certainly there could be some recovery, so that's a fair point.
    – D Stanley
    Apr 14, 2023 at 16:04
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    It might be better to estimate that it's considered more likely to default than 90% of the other bonds at the same coupon rate.
    – Barmar
    Apr 15, 2023 at 14:15

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