Chapter 2.94® - Glossary of Bonds Payable Terms
Annuity – A series of equal instalment payments occurring at regular intervals. For instance, annual payments are once a year, semi-annual payments are made twice a year and quarterly payments are 4 times a year.
Bearer bonds - Bonds payable to whoever holds them (the bearer) are called Bearer bonds (Unregistered bonds). Since there is no recordkeeping in Bearer bonds, whoever holds the title to the bond upon payment date will be presumed its rightful owner. Thus as a result, lost or stolen bearer bonds are difficult to trace and replace.
Bond - A bond is a written guarantee or promise to pay a certain amount as the par value of the bond along with interest at an annual interest rate. Thus, a bond is considered as a short or long term liability for a corporation. If the bond repayment period is greater than 1 year, it is considered as a long term liability; however if the maturity date is within 1 year, the bond is considered a short-term liability.
Bond certificate - The document that states the bond issuer’s name, par value, contract or interest rate, maturity and all other relevant data is known as a bond certificate.
Bond indenture - The legal document that states the rights and obligations of bondholders and issuers is known as a Bond Indenture.
Callable bond - Callable bonds are when the issuing company has the option of retiring them prior to their maturity for a call premium.
Carrying Value – Carrying value of a bond is the net amount at which the bond is reported on the balance sheet; equalling the par value of the bonds minus any unamortized discount or plus any unamortized premium. Carrying value is also known as the book value of the bond.
Contract rate - The total amount of interest paid each year is calculated by multiplying the face value of the bond x stated annual interest rate (also known as the contract rate or nominal rate/ coupon rate). This interest can be paid quarterly (every 3 month), semi-annually (every 6 months) or annually (every 1 year).
Convertible bond - Convertible bonds are when bondholders can exchange their bonds for a fixed number of the issuing company’s common shares. Convertible bonds allow bondholders the potential to increase their net worth by future increases in the market value of the common shares of the issuing company.
Coupon bonds – Bonds that have interest coupons attached to their certificates and upon maturity, bondholders detach the coupons and present them to the bank for reimbursement.
Debenture - Unsecured bonds (also known as Debentures) do not have any collateral assets pledged by the issuing company. Instead, bondholders determine the credit rating of the company before investing their funds in to the bond.
Discount on Bonds Payable – Difference between par value of a bond and its lower issuing price is known as a discount on bond payable and arises when the contract (coupon) rate is lower than the bond’s market rate.
Effective Interest Method - The effective interest method allocates bond interest expense over the life of the bonds in such a way that it yields a constant rate of interest, which in turn is the market rate of interest at the date of issue of bonds. With effective interest method, the bond payable and discount/premium is calculated using the effective market interest rate versus the coupon rate used in straight-line method.
Effective Interest Rate - The market rate of interest (effective interest rate) is the % of interest borrowers are willing to pay and lenders are willing to earn for a certain bond taking in to account its risk level.
Financial Leverage - Bonds can increase financial leverage of an organization because when it earns higher interest with the borrowed funds through bonds issued than what it pays in interest, this increases its return on equity.
Market rate of Interest – The market rate of interest (effective interest rate) is the % of interest borrowers are willing to pay and lenders are willing to earn for a certain bond taking in to account its risk level.
Par value of Bond – The amount a bond is issued at and agreed to be repaid to the bondholder upon maturity. The par value is also the amount on which periodic interest payments are based. Par value is also known as the face value of a bond.
Premium on bond payable - Difference between par value of a bond and its higher issuing price is known as a premium on bond payable and arises when the contract (coupon) rate is higher than the bond’s market rate.
Redeemable bonds – Bonds that allow the holder to retire them at a stated dollar amount prior to maturity.
Registered bonds - Registered bonds are bonds that are issued in the names & addresses of their holders. The issuing company issues interest payments in the form of checks payable to their registered owners and delivered to their homes.
Secured bonds - Secured bonds, as the name suggests, have certain assets of the issuing company pledged as collateral or a guarantee. This protects bondholders and their investments, such that if the issuing company fails to pay the interest payment & principal amount upon maturity, bondholders can demand the sale of secured or collateralized assets in order to pay the bond obligations.
Serial Bonds - Serial bonds on the other hand consist of a bond issue whose component parts become mature at different dates or series of dates. For instance, a $2 million bond might mature at a rate of $200,000 per year after Year 6 until Year 15 when the entire $2 million balance is paid back.
Straight Line Amortization - Straight-line amortization expenses the same amount to expense each period over the useful life of the capital asset.
Term bonds - Term bonds are a series of bond issues that all become due on a single specified date. Term bonds can be short term or long term, and can also be called back or converted to other investments before the maturity date.
Unsecured bonds - Unsecured bonds (also known as Debentures) do not have any collateral assets pledged by the issuing company. Instead, bondholders determine the credit rating of the company before investing their funds in to the bond.