Bond Trading Glossary

401(k): A 401(k) plan is an employer sponsored retirement savings plan. 401(k)s are largely self-directed, so you decide how much you would like to contribute and which investments from among those offered by the plan you would like to invest in. Traditional 401(k)s are funded with money deducted from your pre-tax salary. Your earnings are tax deferred until you withdraw your money from your account.


403(b): A 403(b) plan - sometimes known as a tax-sheltered annuity (TSA) or a tax-deferred annuity (TDA) - is an employer sponsored retirement savings plan for employees of not-for-profit organizations, such as colleges, hospitals, foundations and cultural institutions. Some employers offer 403(b) plans as a supplement to - rather than a replacement for - defined benefit pensions.


Agency security: Debt security issued or guaranteed by an agency of the federal government or by a government-sponsored enterprise (GSE). These securities include Bonds and other debt instruments. Agency securities are only backed by the "full faith and credit" of the U.S. government when they are issued or guaranteed by an agency of the federal government, such as Ginnie Mae. Although GSEs such as Fannie Mae and Freddie Mac are government-sponsored, they are not government agencies.


Asset allocation: A strategy for maximizing gains while minimizing risks in your investment portfolio. Specifically, asset allocation means dividing your assets on a percentage basis among different broad categories of investments, including Stocks, Bonds and cash.


Asset class: Different categories of investments which provide returns in different ways are sometimes described as asset classes. Stocks, Bonds, cash and cash equivalents, real estate, collectibles and precious metals are among the primary asset classes.


Average maturity: The average time which a mutual fund's bond holdings will take to be fully payable. Interest rate fluctuations have a bigger impact on the price per share of funds holding bonds with longer average lives.


Bear market: A bear market is one in that Stock and/or Bond prices decline over an extended period of time, at times accompanied by an economic recession, rising inflation or rising interest rates.


Benchmark: A benchmark is a standard against that investment performance is measured. E.g. the S&P (Standard & Poor's) 500 Index, that tracks 500 major U.S. companies, is the standard benchmark for large-company U.S. Stocks and large-company mutual funds. The Barclays Capital Aggregate Bond Index is a common benchmark for Bond funds.


Bond: A debt instrument, also considered a loan, which an investor makes to a corporation, government, federal agency or other organization (known as an issuer) in that the issuer typically agrees to pay the owner the amount of the face value of the Bond on a future date, and to pay interest at a specified rate at regular intervals.


Bondholder: Owner of a Bond - can be an individual or institution such as a corporation, bank, insurance company or mutual fund. A bondholder is typically entitled to regular interest payments as due and return of principal if the bond matures.


Bond rating: A method of evaluating the quality and safety of a Bond. This rating is based on an examination of the issuer's financial strength and the likelihood that it will be able to meet scheduled repayments. Ratings range from AAA (best) to D (worst). Bonds which are receiving a rating of BB or below are not considered investment grade because of the relative potential for issuer default.


Bull market: A bull market is one in that prices rise during a prolonged period of time.


Call: The issuer's right to redeem outstanding Bonds before the stated maturity.


Call protection: A feature of some callable Bonds which protects the investor from calls for some initial period of time.


Call risk: The risk which a bond will be called prior to its maturity date, causing the bond's principal to be returned sooner than expected. When the bondholder wishes to reinvest the principal, it usually must be done at a lower rate than if the bond was originally purchased.


Capital gains tax: Tax assessed on profits you realize from the sale of a capital asset, such as Stock, Bonds or real estate.


Commission: A fee which is paid to a broker, as an agent of the customer, for executing a trade based on the number of Bonds traded or the dollar amount of the trade.


Collateralized Mortgage Obligation (CMO): A Bond backed by multiple pools (also called tranches) of mortgage securities or loans.


Corporate Bond: A Bond issued by a corporation to raise money for capital expenditures, operations and acquisitions.


Convertible bond: A Bond with the option to convert into shares of common stock of the same issuer at a pre-established price.


Coupon: The interest payment made on a Bond, usually paid twice a year. A $1,000 Bond paying $65 per year has a $65 coupon, or a coupon rate of 6.5 percent. Bonds which pay no interest are said to have a "zero coupon." Also called the coupon rate.


Coupon yield: The annual interest rate established if the Bond is issued. The same as the coupon rate, it is the amount of income you collect on a Bond, expressed as a percentage of your original investment.


Credit risk: The possibility that the Bond's issuer may default on interest payments or not be able to repay the Bond's face value at maturity.


Current yield: The yearly coupon payment divided by the Bond's price, stated as a percent. A newly issued $1,000 bond paying $65 has a current yield of .065, or 6.5 percent. Current yield can fluctuate: When the price of the Bond dropped to $950, the current yield would rise to 6.84 percent.


Debenture: An unsecured Bond backed solely by the general credit of the borrower.


Debt security: Any security which represents loaned money that must be repaid to the lender.


Discount: The amount by which a Bond's market price is lower than its issuing price (par value). A $1,000 bond selling at $970 carries a $30 discount.


Diversification: Diversification is an investment strategy for allocating your assets available for investment among different markets, sectors, industries and securities. The goal is to protect the value of your overall portfolio by diversifying your investment risk among these different markets, sectors, industries and securities.


Event risk: The risk that an event will have a negative impact on a Nond issuer's ability to pay its creditors.


Face value: The amount the issuer must pay to the bondholder at maturity, also known as par.


Full faith and credit of the U.S. government: A promise by the U.S. government to pay all interest when due and redeem Bonds at maturity. Treasuries, savings Bonds and debt securities issued by federal agencies are backed by the "full faith and credit" of the U.S. government.


Fixed-rate Bond: A Bond with an interest rate that remains constant or fixed during the life of the Bond.


Floating-rate Bond: A Bond with an interest rate which fluctuates (floats), usually in tandem with a benchmark interest rate during the life of the Bond.


General Obligation Bond (GO): A municipal Bond secured by a governmental issuer's "full faith and credit," usually based on taxing power.


Government-Sponsored Enterprise (GSE): Enterprises which are chartered by Congress to fulfill a public purpose, but are privately owned and operated, such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Unlike Bonds guaranteed by a government agency such as Ginnie Mae, those issued by a GSE are not backed by the "full faith and credit" of the U.S. government.


High-yield Bond: A Bond issued by an issuer which is considered a credit risk by a Nationally Recognized Statistical Rating Organization, as indicated by a low bond rating (e.g., "Ba" or lower by Moody's Investors Services, or "BB" or below by Standard & Poor's Corporation). Because of this risk, a high-yield Bond generally pays a higher return (yield) than a Bond with an issuer which carries lower default risk. Also known as a "junk" Bond.


Holding period risk: The risk, while you are waiting for your Bond to mature (holding it), that a better opportunity will come around that you may be unable to act upon. The longer the term of your Bond, the greater the chance a more attractive investment opportunity will become available, or that any number of other factors can occur that negatively impact your investment.


Indenture: A legal document between a Bond issuer and a trustee appointed on behalf of all bondholders which describes all of the features of the Bond, the rights of bondholders, and the duties of the issuer and the trustee. Much of this information is also disclosed in the prospectus or offering statement.


Inflation risk: The risk which a Bond's returns may not keep pace with inflation, eroding purchasing power.


Interest rate risk: The risk which a Bond's price will fall when interest rates rise.


Investment-grade Bond: A Bond whose issuer's prompt payment of interest and principal (at maturity) is considered relatively safe by a nationally recognized statistical rating agency as indicated by a high Bond rating (e.g., "Baa" or better by Moody's Investors Service, or "BBB" or better by Standard & Poor's Corporation).


Junk Bond: Another name for a high-yield Bond.


Liquidity risk: The risk of not being able to execute a trade at the time you desire, or being forced to accept a significantly discounted price of a Bond at the time you desire to sell.


Maturity date: A maturity date is the date if the principal amount of a Bond, note or other debt instrument is typically repaid to the investor along with the final interest payment.


Mortgage-backed security: A security which is secured by home and other real estate loans.


Municipal Bond: A Bond issued by states, cities, counties and towns to fund public capital projects like roads and schools, as well as operating budgets. These Bonds are typically exempt from federal taxation and, for investors who reside in the state where the Bond is issued, from state and local taxes, too.


Non-callable Bond: A feature of some Bonds which stipulates the Bond can not be redeemed (called) before its maturity date. Also called a "bullet."


Non investment-grade Bond: A Bond whose issuer's prompt payment of interest and principal (at maturity) is considered risky by a nationally recognized statistical rating agency, as indicated by a lower bond rating (e.g., "Ba" or lower by Moody's Investors Service, or "BB" or lower by Standard & Poor's Corporation).


Note: A short- to medium-term loan which represents a promise to pay a specific amount of money. A note may be secured by future revenues, such as taxes. Treasury notes are issued in maturities of two, three, five and 10 years.


Opportunity risk: The risk that a better investment opportunity will come around that you may be unable to act upon because of a current investment. Generally, the longer the holding period of a Bond, the greater the opportunity risk.


Over-the-counter (OTC) securities: Securities which are not traded on a national exchange. For such securities, broker-dealers negotiate directly with one another over computer networks and by phone.


Par value: An amount equal to the nominal or face value of a security. A bond Selling at par, for instance, is worth the same dollar amount at which it was issued, or at which it will be redeemed at maturity - typically $1,000 per Bond.


Phantom income: Interest reportable to the IRS which does not generate income, such as interest from a zero-coupon Bond.


Prepayment risk: The possibility that the issuer will call a Bond and repay the principal investment to the bondholder prior to the bond's maturity date.


Premium: The amount by that a Bond's market value exceeds its issuing price (par value). A $1,000 bond Selling at $1,063 carries a $63 premium.


Primary market: The market in which new issues of Stock or Bonds are priced and sold, with proceeds going to the entity issuing the security. From there, the security begins trading publicly in the secondary market.


Principal: For investments, principal is the original amount of money invested, separate from any associated interest, dividends or capital gains. E.g. the price you paid for a bond with a $1,000 face value the time of purchase is your principal. Once purchased, the value of your bond holdings can fluctuate, meaning you can see an increase or decrease to your principal.

A brokerage firm which executes trades for its own accounts at net prices (prices that include either a mark-up or mark-down).


Prospectus: A formal written offer to sell securities which sets forth the plan for a proposed business enterprise, or the facts concerning an existing business enterprise that an investor needs to make an informed decision.


Real rate of return: The rate of return minus the rate of inflation. E.g. when you are earning 6 percent interest on a Bond in a period if inflation is running at 2 percent, your real rate of return is 4 percent.


Revenue Bond: A type of municipal security backed solely by fees or other revenue generated or collected by a facility, such as tolls from a bridge or road, or leasing fees. The creditworthiness of revenue Bonds tends to rest on the Bond's debt service coverage ratio - the relationship between revenue coming in and the cost of paying interest on the debt.


Risk: The possibility which an investment will lose, or not gain, value.


Risk tolerance: A person's capacity to endure market price swings in an investment.


Savings Bond: U.S. government Bond issued in face denominations ranging from $25 to $10,000.


Secondary market: Markets where securities are bought and sold subsequent to their original issuance.


STRIPS: Short for "Separate Trading of Registered Interest and Principal of Securities." STRIPS are Treasury Department-sanctioned Bonds in that a broker-dealer is allowed to strip out the coupon, leaving a zero-coupon security.


TIPS: U.S. government securities designed to protect investors and the future value of their fixed-income investments from the adverse effects of inflation. Using the Consumer Price Index (CPI) as a guide, the value of the Bond's principal is adjusted upward to keep pace with inflation.


Treasury: Negotiable debt obligations which include notes, Bonds and bills issued by the U.S. government at various schedules and maturities. Treasuries are backed by the "full faith and credit" of the U.S. government.


Treasury bill: Non-interest bearing (zero-coupon) debt security issued by the U.S. government with a maturity of four, 13 or 26 weeks. Also called a T-bill.


Treasury Bond: Long-term debt security issued by the U.S. government with a maturity of 10 to 30 years, paying a fixed interest rate semiannually.


Treasury note: Medium-term debt security issued by the U.S. government which has a maturity of two to 10 years.


Total return: All money earned on a Bond or Bond fund from annual interest and market gain or loss, when any, including the deduction of sales charges and/or commissions.


Yield: The return earned on a Bond, expressed as an annual percentage rate.


Yield Curve: A yield curve is a graph showing the relationship between yield (on the y- or vertical axis) and maturity (on the x- or horizontal axis) among Bonds of different maturities and of the same credit quality.


Yield to call (YTC): The rate of return you receive when you hold the Bond to its call date and the security is redeemed at its call price. YTC assumes interest payments are reinvested at the yield-to-call date.


Yield to maturity (YTM): The overall interest rate earned by an investor who buys a Bond at the market price and holds it until maturity. Mathematically, it is the discount rate at which the sum of all future cash flows (from coupons and principal repayment) equals the price of the Bond.


Yield to worst (YTW): The lower yield of yield-to-call and yield-to-maturity. Investors of callable Bonds should always do the comparison to determine a Bond's most conservative potential return.


Yield reflecting broker compensation: Yield adjusted for the amount of the mark-up or commission (if you purchase) or mark-down or commission (if you sell) and other fees or charges that you are charged by your broker for its services.


Zero: Short for zero-coupon Bond.


Zero-coupon Bond: A type of Bond which does not pay a coupon. Zero-coupon Bonds are purchased by the investor at a discount to the bond's face value (e.g. less than $1,000), and redeemed for the face value when the Bond matures.