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What is a Corporate Bond?
A corporate bond is a debt security issued by a public or private company to raise capital. They are generally issued in multiples of $1,000 or $5,000, and the issuing company must agree to pay a certain interest rate typically determined by their creditworthiness and earning history/potential. Often times the corporation issuing the debt must use their physical assets as collateral, and it is often found that corporations are more likely to issue debt during an environment when interest rates are low, so they can borrow at attractive rates. Corporate debt that matures in less than one year is called ‘commercial paper.’ Continue reading...
What is a Bond Coupon?
A bond coupon is the interest rate that a bond issuer agrees to pay to the bondholder, representing the interest earned from owning the bond. Bond coupons are fixed at the time the bond is issued and remain constant throughout the bond's life. The fixed nature of bond coupons makes them an attractive investment for investors seeking predictable income streams. Continue reading...
What are Risk-Weighted Assets?
International banking regulations set forth in the Basel Accords require that institutions maintain a certain amount of capital relative to the amount of risk-weighted assets (RWA) they have. Conservative investments such a treasury notes have a risk weighting of zero, while corporate bonds have a weighting of .20, and so forth. The exact weighting system is laid out in Basel agreements. The system is designed to reveal a bank’s level of exposure to potential losses, and the capital requirements are there to balance out the risks and to protect the global economy from a meltdown in the financial system. Continue reading...
What is a Zero Coupon Bond?
A Zero Coupon Bond is one that does not make interest payments - the bondholder only receives the face value back at time of maturity. The bond purchaser typically pays a deep discount for the bond, and the gain made over the life of the investment is the difference between the amount paid for the bond and the face value returned to the investor when the bond matures. What is a Bond Coupon? Is There Anything Else I Need to Know About Bonds? Continue reading...
What is a "spread"?
Spread has several meanings in finance, but the most general usage is to describe the difference between the bid and the ask prices for a security, where a narrower spread would indicate high trading volume and liquidity. It also might refer to a type of options strategy in which an investor purchases two calls or two puts on the same underlying security but with different expiration dates or strike prices. Continue reading...
What is a Dividend Rate?
The dividend rate is basically just the value of the annual dividend of a company, stated as the monetary value. Not to be confused with the dividend yield, or the dividend growth rate, both of which are percentages. Dividend yield and dividend rate are slightly different from one another. The dividend yield is the size of a dividend in relation to the share price, and is stated as a percentage. The dividend rate is actually the amount of money paid out per share, per year, stated as a dollar amount. Continue reading...
What is the Structure of a Corporation?
Each state has different stipulations concerning what defines a corporation, but there are some commonalities across the country. Businesses must file Articles of Incorporation with the Secretary of State in the state of their home office, which detail the proposed structure of the business, before their status as a corporation can be approved. Each corporation is going to be different, of course, and each state has slightly different laws delineating the structure and bylaws that corporations must adopt. Continue reading...
What Types of Bonds Are There?
Bonds are divided into a several categories, and it is possible to get substantial diversification within a bond portfolio alone. Bonds may be categorized into several types. There are investment grade bonds which are conservative and safe, high-yield bonds which are relatively risky and profitable, floating rate bonds whose coupon rate is not fixed, zero coupon bonds which only pay at maturity, and foreign bonds, and so on. Continue reading...
What is Bond Insurance?
Bond insurance is a contract that protects the issuer and the holder of bonds from the risk that bond payments will not be made. Bond issues from the corporate or municipal world, or from derivative sources as with asset-backed securities and CDOs, come with the risk of default-- that is, that payments will not be made on time. The major credit ratings agencies (CRAs) assign a risk of default to each bond issue with proprietary analysis methods and ratings. Continue reading...
What is Income Risk?
Income risk is the chance that an investment which is used for income will fluctuate in an unfavorable way if the interest rate environment or market conditions change. Some mutual funds and ETFs are branded as income funds when they use lots of corporate bonds that generate regular income payments, but they are often sensitive to interest rate changes. The Federal Reserve Board and the market can affect changes in the interest rate environment as times goes on. Continue reading...
What is a Bond?
A bond is a contract which “binds” the lender to the debtor, where an individual investor is generally the lender and the debtor is the company or government which has borrowed funds. When a company or government entity needs more capital, whether to fund operations or a specific project, it can borrow money from investors instead of from a banking institution. Where there is a risk of the investor not being repaid, the interest rate will be proportionally higher. The simplest way a bond works is with set payments at set intervals that gradually repay the debt and interest owed to the investor over a set amount of time. Continue reading...
What is an Income Bond?
Income bonds are issued by companies and they will only pay a coupon or interest rate if the company generates adequate earnings to do so. Non-payment of a coupon or interest rate does not necessarily mean that the company is in default. The principal amount plus some interest is due to the bondholder at maturity. Income bonds are sometimes issued by companies who are experiencing hard times and cannot guarantee a coupon payment to bondholders. Continue reading...
What is a foreign currency swap?
These are generally referred to as currency swaps or cross-currency swaps , since “foreign” is a little redundant (currencies are from different countries anyway). Central banks and large institutions sometimes swap principal amounts and loan interest in their domestic currency in exchange for a foreign currency, to provide liquidity and a hedge. Currency swaps are where banking institutions, particularly central banks, exchange a loan in one currency for a loan in another currency. Continue reading...
What is an S-Corporation?
S-Corporations, also called S-corps, are a cross between a traditional corporation and an LLC. S-Corporations are companies which, as opposed to C-Corporations, do not pay any federal income tax on their earnings, except in a few exceptional cases. Instead, the earnings (or losses) are passed to the shareholders and will appear on their individual income tax reports. The “S” comes from the subchapter of the Internal Revenue Code where the taxation laws are outlined. S-corps can actually be owned and operated by a sole proprietor after incorporating or starting an LLC in the state of residence and filing IRS form 2253 (link to instructions and form — found here). Continue reading...
What is a Callable Bond?
A callable bond, also known as a “redeemable bond,” is one where the issuer has the ability to pay off the debt prior to its maturity date, with certain conditions. Which the issuer has the right to redeem prior to its maturity date, under certain conditions. The primary reason that an issuer would choose to “call” a bond is that interest rates have declined since the bond was issued. By calling the bond, the issuer generally has to opportunity to refinance that debt at a lower rate. Once called, the issuer will notify the creditor and pay off the debt, typically with a slight premium added to close the deal. Continue reading...
What is a Convertible Bond?
A convertible bond, also known as convertible debt, is debt that can be converted to equity (in the form of common stock) at the discretion of the bondholder. There are typically windows that an investor can choose to convert the bond to equity, which an investor may choose to do if they have confidence the company will continue to perform well. Because a convertible bond has the option to convert to stock, it typically offers a lower interest rate since the conversion capability itself has value. Continue reading...
What is a Corporation?
A corporation is a business entity which has filed articles of incorporation. Unlike a Sole Proprietorship or a Partnership, a corporation is a legal entity that is separate from its owners. They are often referred to as C-corporations or C-corps, to distinguish them from S-corps, which are named after the subchapter which describes them in the law (though technically speaking, S-corps are corporations, too). Continue reading...
What are Municipal Bond Funds?
Municipal bonds funds invest exclusively in tax-advantaged municipal bond issues. Municipal Bond Funds invest in issues of municipal debt, often with the intention of using its tax advantages. Bonds held in a ‘muni fund’ might be state or local issues of general obligation or revenue bonds. Gains on muni funds are not taxable at the federal level, and if a person resides in the state in which the bond was issued, they can most likely avoid state or local taxes on gains as well. Continue reading...
What is a Dividend?
A dividend is an income-like payment to an investor who holds stock. Dividends tend to be paid by companies who are well established and are not retaining their earnings for capital projects. There are several kinds of dividends, but the most common is the cash dividend. You are not likely to see dividends paid by companies whose stocks are categorized as Growth stocks. Growing companies are going to be ploughing money back into their company for years. Well-established companies tend to distribute some of their profits as dividends because it allows them to retain loyal shareholders and keep the price of the stock fairly steady. Continue reading...
What are Balanced Funds?
Balanced funds offer a well-diversified investment that includes relatively equal exposure to stocks and bonds. Balanced funds combine stocks, bonds, and money market instruments to give investors some upside potential along with a goal of capital preservation. While they are considered to be safer, they also have more modest returns in most market environments, because, of course lower risk investments have lower potential returns. Continue reading...