Characteristics of interest rate securities

An Interest Rate Security has the following characteristics:

An Issuer
An Organisation which issues a bond is referred to as 'the issuer' or 'the borrower'. The most active issuers of bonds today are governments and government agencies (government bonds), banks and corporations (corporate bonds).

Face Value
Face Value is the amount that is to be paid to an investor at the maturity date of a bond. Bonds can be issued at different face values, however, in Australia, bonds typically have a unit face value of $100.

Interest Coupon
A coupon represents an interest payment paid at regular intervals by the issuer to owners of Interest Rate Securities. The coupon rate is the interest rate paid to investors during the life of the bond and is set when the issuer first sells the securities into the market. The coupons vary according to the type of Interest Rate Security.
A fixed rate bond has a coupon that is fixed for the life of the bond. A floating rate note has a coupon that varies in line with a benchmark rate, usually at a margin above the bank-bill rate, and is different at each payment date. Since the amount of coupon interest is known in advance, its accumulation is spread over each payment period. This is referred to as the daily accrued interest. It contrasts with a share dividend which is only known shortly before it is paid.

Coupon Frequency
Coupon payments are made at regular intervals throughout the life of the bond and are usually quarterly or semi-annually. Fixed rate bonds generally have semi-annual coupon payments while floating rate notes normally pay interest quarterly.

Yield
The Yield is the return an investor receives on a bond. The yield is based on the price paid by an investor for a bond and the payments (coupons) received if the bond is held to maturity. The most important types of yield are the nominal yield and the yield to maturity.

Nominal yield, also known as the coupon rate, is the cash flow investors receive from a bond and does not change throughout the life of the bond (except in the case of a floating rate note). Yield to maturity is the return an investor receives at a given price. It is the most useful indicator of the value of a bond because it enables comparisons to be made of the return between different types of Interest Rate Securities and interest rate based products.

Maturity Date
The final coupon and the face value of a bond is repaid to the investor on its maturity date. The time to maturity can vary greatly, although in Australia it is typically between 2 and 20 years. Perpetual Securities are a type of bond with no maturity date. To redeem this type of investment, investors must sell the security 'on market'.

Purchase Price
The purchase price (also known as the gross price) is the total amount that an investor pays for a bond. Purchase price comprises the number of bonds that an investor buys times the price paid for a bond.

The purchase price includes two components:

  • Capital price which is the price of the bond as estimated by the market based on a number of variables including interest rates, maturity date, ranking and credit quality.
  • Accrued interest on the bond which is the amount of interest accumulated on a bond since the last coupon payment. Because interest is paid at regular intervals the bond price increases daily by the amount of interest accruing. On a 6.50 per cent annual coupon, interest accrues at 1.78 cents per $100 per day. Immediately following the coupon payment the price should fall by the amount of that coupon payment.

Gross Price
The gross price of a bond is determined by adding any accrued interest to its capital price. The prices quoted on ASX Interest Rate Security Market reflects a gross price.