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If I buy a bond at par value (1000 $) and hold it to maturity, is it true that I will get my 1000 back (assuming the company does not default)? I don't get this part because what if:

  1. Company does not default but says I can only pay you 500, not 1000?
  2. What if at the time of maturity, the price of the bond on the market is 800 $? Or is it not possible because on maturity date, the bond will not trade any more? (sine it has 'matured')?
8

If the company only pays back $500 instead of $1000, that's a default. By definition, so long as the company does not default, they will pay back the face value of the bond. That is what it means to not default.

The market price could be $800, though this would be extremely unusual. More likely, the market price would be almost exactly the bond's par value if the market's expectation was that the bond would be repaid. In the highly, highly unusual case where the market value is $800, the bond issuer would still have to pay back the full face value (or default).

Keep in mind that defaults are not unusual in riskier bonds. Heck, defaults are not unheard of in so-called 'safe' bonds, either. Additionally, you take the risk that inflation may wipe out the profits you make from the bond. They are not risk-free.

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No

Any bond has a risk of default; this risk is much lower in the case of gilts, i.e. bonds backed by a country. This is why there is a big industry that attempts to rate all the different bonds.

The normal advice for the average investor, i.e. some one who is not Buffet or Bill Gates, is to not directly buy individual bonds (ignoring Gilts and T Bills for now, as they are different) but to buy a bond fund which invests in many bonds to reduce the risk of losing money.

In the UK recently, a few mutual bonds (PIBS) went into default and some foolish investors had over 50% of their savings in a single security! and lost a lot of money.

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  • "... i.e. bonds backed by a country" The term you're looking for is sovereign debt. I'm actually not sure how this answers the question, since bond funds may not hold the bonds in them to maturity and the OP specifically excluded default. – John Bensin Aug 19 '13 at 11:01
  • +1 for the suggestion to use a bond fund to spread your risk. City of Detroit, State of Illinois, need I say more? – JAGAnalyst Aug 21 '13 at 20:41
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No.

There are instances where a company/government undergoes debt restructuring, in which, assuming bondholders agree, the issuer can extend, consolidate, or refinance its debt at a lower interest rate, longer duration, etc. Bondholders could agree to swap their current bonds for bonds that mature at a later date, so at the maturity date of their original bonds, they won't receive the par value; instead, they'll receive the par value of the new bonds at the new maturity date.

This isn't necessarily equivalent to a default, because the issuer still agrees to pay the par value of a bond at its maturity date, but it is a situation in which you might not receive the par value at the original maturity date. This is often different from a default, because bondholders may still receive the par value of a bond at its maturity date, even though it's not the par value of the original bond at the original maturity date.

However, a debt restructuring that extends the duration of your bond may open you up to an increased risk of default. Since there is more time left before the new bond matures, there is more time for the issuer to find itself in financial distress and default on its debt. There isn't any guarantee that it won't decide to either restructure its debt again, undergo a different kind of restructuring, e.g. a debt-for-equity swap, in the case of a company, or default before the new bonds reach maturity.

There is another situation where you may receive an amount greater than or equal than the par value, but not at the maturity date: callable bonds. With these bonds, the issuer of the bond is allowed to buy the bond back from the owner at a specified call price.

Since the call price usually exceeds the par value, this isn't necessarily a concern, but it's something to keep in mind if you're basing an asset allocation or investment on the assumption that you'll hold the bond to maturity and receive the par value at that time.

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  • I think that debt restructuring cannot be forced on a bond holder unless the company is in bankruptcy, which means its in default. So your answer isn't correct IMHO. – littleadv Aug 19 '13 at 0:49
  • @littleadv Right, that wasn't clear. I said that "bondholders may agree..." and provided an example, but that might make it seem like even if they don't agree, the restructuring can go ahead regardless. – John Bensin Aug 19 '13 at 0:54
  • actually in the UK I have seen non bankrupt companies taken over by their bond holders in a debt for equity it may be different in the USA. – Neuromancer Aug 19 '13 at 8:18
  • @Neuromancer My answer wasn't specific to the US, however. Debt restructuring laws can vary significantly from jurisdiction to jurisdiction, so I tried to keep it as general as possible. Furthermore, the reality can be very different in cases of sovereign financial distress. – John Bensin Aug 19 '13 at 11:03

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