Facts about Corporate and Municipal Bonds
What is a bond?
Bonds are debt securities. They are issued by corporations and government entities (US Treasury, state, and local municipalities). The investor is lending money to the borrower.
Why buy bonds?
Bonds provide a consistent stream of income since they usually pay interest payments twice a year. They offset some of the volatility from owning stocks
Bond Terms
Face value is the amount the bond is worth when issued. Bonds are issued in multiples of $1,000. This is also known as par value. The face value is what the bond holder receives when the bond reaches maturity.
Coupon is the interest rate paid on the bond. The interest rate is stated on the bond and does not change. They are called coupons since they were historically issued in the form of bearer certificates with coupons attached for each scheduled interest payment.
Yield or fair market value of bond changes over time since the purchase price fluctuates on the secondary market. The price of a bonds increases or decreases depending on the value of the interest income compared to market interest rates.
Bond premium is when bonds are purchased for an amount that is greater than the face value of the bond. When interest rates go down the purchase price of the bond goes up. This is because the investor receives a higher stated interest rate on the existing bond than a bond issued at the prevailing interest rate.
Bond discount is when bonds are purchased for an amount that is lower than the face value of the bond. When interest rates go up the purchase price of the bond goes down. This is because the investor receives a lower interest rate on the existing bond than a bond issued at the prevailing interest rate.
Bond amortization is the adjustment to bring the bond premium down (amortize) to the face value of the bond.
Bond accretion is the adjustment to bring the bond discount up to the face value of the bond
Accrued interest paid on purchase is the amount of interest earned but not collected. This is important when a bond is purchased on the secondary between coupon dates. The cost of the accumulated interest is included in the purchase price of the bond. This is how the bond holder that sold the bond receives the interest earned through the sale date.
Relieved accrued interest paid on purchase – is the accrued interest paid that can be deducted from interest income after you receive the interest income from the bond. Only the amount you receive can be deducted. If the accrued interest you paid is $100 and you only received $80 of interest, only the $80 can be deducted. The remaining accrued interest cannot be deducted until you receive it.
Susan Prizant is a Tax Manager at Katz, Nannis + Solomon, P.C. If you have any questions or would like to speak with one of our tax professionals, please contact our office at 781-453-8700.