Bonds can be purchased from government agencies or private companies. By buying bonds, you are lending money to the bond issuer. This money, called the "principal" of the bond, will be returned within months or years, when the bond matures. In addition to the principal of the bond, investors also receive interest paid by the issuer until the bond matures. To determine the amount of interest income you receive each year, month, or six months, you must be able to calculate the amount of interest payments on a bond.
Step
Part 1 of 2: Understanding Bond Payments
Step 1. Study bonds
Buying bonds can be likened to buying debt, or lending to a company. These bonds themselves reflect the related debt. Like ordinary debt, bond issuers must pay interest at fixed intervals over a certain period of time, and return the principal of the bonds to investors when the debt matures..
Companies and governments issue bonds to raise project costs, or fund day-to-day operations. Instead of borrowing from banks, companies issue bonds to obtain lower loan interest rates and escape the restrictions of bank regulations
Step 2. Learn terms related to bond interest payments
There are many unique terms when dealing with bonds, and you need to understand them to be able to invest in bonds properly and calculate the interest income received.
-
Face value (par).
The face value of the bond can be considered as the principal of the debt. This is the initial loan amount and is returned when the bond matures.
-
Maturity (maturity).
The end of the loan term is called maturity. This is the principal repayment date of the loan to bond investors. By knowing the maturity date of the bond, you also know the length of the bond's term. Some bonds can have maturities of 10 years, 1 year, or even 40 years.
- Coupon. Coupons can be thought of as interest payments on bonds. Bond coupons are usually presented as a percentage of the face value of the bond. For example, a bond may have a coupon of 5% against the face value of the bond of $10,000,000. In this case, the coupon value is IDR 500,000 (0.05 times IDR 10,000,000). Please note that the coupon interest rate is always in annual terms.
Step 3. Distinguish between coupon and bond yields
It is important to know the difference between yield (rate of return on investment) and coupon bonds so as not to miscalculate interest income.
- Sometimes bonds include yield and coupon numbers. For example, the coupon for a bond may be 5%, and the yield value is 10%.
- This is because the value of a bond can fluctuate over time, and the yield is the percentage of annual coupon payments from its “present value”. Sometimes, bond prices go up and down, which means the bond price becomes different from the face value.
- For example, suppose you buy a bond with a face value of $10,000,000. The coupon interest rate for this bond is 5% or IDR 500,000 per year. Now, say the price of your bond drops to $5,000,000 in the first year due to a change in interest rates. Bond yield to 10%. Since the bond yield is a coupon payment based on its present value, the coupon value (Rp500,000) becomes 10% of its present value (Rp5,000,000). When bond prices fall, the percentage yield goes up.
- Bond market prices change due to market fluctuations. For example, if at the time a bond is purchased the long-term interest rate rises from 5% (equal to the coupon rate), the market price of a $10,000,000 bond drops to $5,000. Since the bond coupon is only IDR 500,000, the market price must drop to IDR 5,000,000 when the interest rate is 10% to attract investors to buy the bonds.
- Although it seems complicated, you don't need to worry because in calculating bond interest rates, only the coupon value needs to be known. If you're observant, you'll notice that in the two examples above, even though the percentages are different, the payout amounts are the same.
- Remember that if you don't sell the bonds and hold them to maturity, the principal of the bonds will be received regardless of the current market price of the bonds.
Part 2 of 2: Calculating Interest Payments on Bonds
Step 1. Look at the face value of the bond
Typically, bonds have a face value of IDR 5,000,000 and multiples thereof. Remember, the face value of the principal of the bond is returned at maturity.
Assume in this case the face value of the bond is $5,000. that is, you lend Rp5,000,000 and expect that amount to be returned on the due date
Step 2. Know the bond's "coupon" rate when it was issued
This interest rate is stated in the bond document. Coupon interest rates can also be referred to as nominal or contractual interest rates.
- The coupon interest rate is determined when the bonds issued are unchanged and is used to determine interest payments until the bonds mature.
- In this case, assume a coupon rate of 5%.
Step 3. Multiply the face value of the coupon rate
Multiply the face value of the bond by the coupon rate to get the amount of interest in rupiah each year.
- For example, if the face value of the bond is $10,000,000 and the interest rate is 5%, multiply the two to find out exactly how much money you receive each year.
- Remember, when multiplying percentages, first convert the number to a decimal fraction. For example 5% becomes 0.05.
- IDR 10,000,000 times 0.05 is IDR 500,000. Thus, your annual interest income is IDR 500,000.
Step 4. Calculate the interest payment for each bond
Interest is usually paid twice a year.
- This information is stated when buying bonds.
- If the bond is paid twice a year, the annual payment needs to be divided by two. In this case, you will receive IDR 250,000 every six months.
Step 5. Find the monthly interest
If the bond interest is paid monthly, use the same approach as above, but divide the annual interest payments by 12 because there are 12 months in a year.
- In this case, IDR 500,000 divided by 12 is IDR 41,600, which means you receive an interest income of IDR 41,600 each month.
- You receive interest only for the days of bond ownership. If you buy a bond between interest-paying days, the amount of interest owed from the previous owner during the bond's tenure will be included in the selling/market price of the bond.
Tips
- Economic factors can affect the value of bonds. These factors include the prevailing interest rates in the bond market, the inflation rate, and the risks inherent in the bond issuing institution. For example, if the issuing company is in financial trouble or is on the verge of bankruptcy, the interest rate may be higher so that investors are still interested in buying it even though the investment risk is very large.
- The advantage of buying bonds is the interest income that continues to come every month and is usually payable on a semi-annual basis.
- Bonds have three main categories based on their maturity date. Short-term bonds mature in one year or less. Medium term/intermediate bonds mature in 2-10 years. Long-term bonds take more than 10 years to mature. High interest rates are usually attached to bonds with very long maturities.
