When you purchase a bond, you are making a loan to the bond issuer in exchange for the payment of interest and the promise to repay to you the original purchase price of the bond. The bond issuer, which may be a corporation or government entity, agrees to certain terms in exchange for your investment. The prospectus, also called the offering statement, provides the information you need to know about the corporation and the bond before making an investment decision. The Securities Industry and Financial Markets Association recommends a careful reading of the prospectus before purchasing bonds.
The U.S. Securities and Exchange Commission requires bond issuers to file with the Commission a prospectus for new or proposed bond offerings. The prospectus is a formal written offer to sell bonds, which are called debt securities. A prospectus provides detailed information about the bond issuer, the terms of the agreement between the bond issuer and the bondholder and details about the characteristics of the bond. Investors use the information provided in the prospectus with information from other sources, such as rating agencies, to assess risk and evaluate earnings potential. An investor advisor, broker or bond issuer can provide you with the prospectus and other research.
The prospectus includes the predetermined interest rate, also is called a coupon rate, which is set at the issuance of fixed-income security bonds. The yield or return on your investment is determined by the interest rate and the face value of the bond purchase. The legal agreement between the bond issuer and the bondholder includes a schedule for making interest payments to investors, such as the semi-annual payment that are common with corporate bonds, over the life of the bond.
The prospectus provides details about the bond’s maturity date, which determines the length of time you must hold the bond before repayment of the principal. The maturity date is the date on which the issuer agrees to pay the bondholder the original purchase price, or principal amount, and the final interest payment. The maturity date, which most bonds have, may be short-, medium- or long-term, ranging from one year up to 100 years (Ref 5).
Early Call Provisions
Investors look for information in the prospectus about early call provisions and protections. This information alerts you to the possibility that the bond will not reach maturity and what, if any, protections you have against the risk. Investors who purchase callable bonds, which the issuer may call earlier than the maturity date, are subject to early repayment of the principal. Call protection provisions protect the investor from early calls for a specified period of time. The prospectus may also include information about a call risk, which is the risk that the issuer will call the bond before its maturity date. Investors who receive early payment and want to reinvest often must purchase bonds at lower rates than those available when the bond was originally purchased.
Credit Rating and Risk
Details of the bond issuer’s plans to raise money for repayment of investments are included in the prospectus. Also included in the prospectus is the bond’s directional outlook, which affects future market favorability. Projections for how much investors will pay for the bond are important to know if you might sell the bond in the future. The prospectus includes information about the bond’s credit rating, which helps determine the issuer’s ability to repay investors as scheduled. A high credit rating, the highest of which is AAA, means there is a lower risk of default. A low credit rating means there is a higher risk of default. Look to the prospectus for other information about risk, such as the bond issuer’s liquidity and performance. The prospectus will include whether the bond is insured, which means if the issuer defaults the insurance company repays investors.
- Financial Industry Regulatory Authority: Bond Basics – What’s a Bond?
- Securities Industry and Financial Markets Association: Key Bond Investment Considerations, Part 2
- InvestingInBonds.com: Types of Bonds
- InvestingInBonds.com: Bonds and Bond Funds – What You Should Know
- Financial Industry Regulatory Authority: Bond Maturity
- InvestingInBonds.com: What You Should Know
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