Corporate bonds have 3 basic features, the Par Value, the interest rate (or coupon) and the length of time to maturity. Next to these 3 elements, the covenants issue just as the conversion rights must be taken into consideration.

Considering the Par value, also called the face value, it represents the price at which the issuer issued the bond first. This Par value can also be the redemption price, it means, the market price at which the bonds can be redeemed by another investor.

As for the interest, generally, bonds have a fixed coupon rate, as a percentage of face value, until it matures. The payment is also known as the coupon. However, some other types of bonds can present a various interest rate. For instance, the floating rate bonds have coupon set at a predetermined margin above a specified money market rate. On the other hand, are also possible the deep discount bonds which offer a zero coupon but allow the investors to make a return by acquiring the securities at a significant discount to their redemption price. Then, the set up bonds which gives investors a higher coupon after an initial period and can be coupled with an issuer call-option to enable the issuer to redeem the bond before it matures (if there is, for instance, an increase in the interest charge).

Coming to the maturity of bonds, the common maturity is at least one year and can be ranged to 30 years and above for certain securities. For instance, hybrid bonds (convertible bonds usually) can be perpetual and present more and more a put-option for the bondholders that allow them to force the redemption in certain circumstances like a change of ownership by the issuer.

Then, concerning the covenants, they are less extensive for bonds than for loans. It is difficult to get the consent of every bondholder when they consist of a large and dispersed group, this is why the UK market practice involves the appointment of a trustee empowered to make largely immaterial changes, for convening meetings of bondholders to consider matters affecting their interests, changing to the terms and for taking enforcement action in case of an event of default from the issuer. Mostly, bonds can present restrictive covenants or protective covenants like restriction on additional debts, pay-out constraints, negative pledge, etc. all these covenants are not used in the euro, sterling bond market thanks to the mandatory legal capital rules in Europe which prevent a company from diluted its assets. However, one covenant has been tightened up, the relation to change of control for which bondholders like to have put option to protect themselves against prejudicial consequences of a buy out.

Finally, the conversion right can be highlighted as a term of bond. When the bond dispose of a convertible right, such provision entitles bondholders to force conversion of their debt instruments into equity securities of the issuer of another company of the group. The number of shares into which the bonds can be converted is determined at the time the bond is issued. Usually, convertible bonds have restrictive covenants with them, prevented the issuer from diluted the economic value of the conversion option (about capital reorganisations, issue of new shares, etc.).

As for current yield, it expresses the current income the bondholder is supposed to have for a period of only one year and gives the ratio of annual interest payments to the bond's market price. We get this ratio by dividing the annual income (the coupon) by the current price of the security (which is the market price, which can be the face value as well). The problem is, the current yield is not taking into consideration the possible changes in the prospective price increases or decreases and focuses only on current income. In order to know what the total rate of return a bond can have,

We need a measure of return that takes into consideration the current yield and the change in bond's value over its life. This measure is the Yield to maturity and which answer to this question: "At what interest rate would the bond be correctly priced?". The yield to maturity is the rate for which the present value of the bond's payments equals the price". In other words, it is the anticipated return we will have if we hold the bond until it matures,which assumes that all interest payments can be reinvested at the same rate.

If you buy a bond at face value, the yield to maturity is the coupon rate, But if you buy a bond at a Premium(or discount), the yield to maturity is less(or higher) than coupon rate. In order to calculate this measure, we need, the annual income (the coupon), the current market value, the maturity value (which is the face value of the bond) and the length of time to maturity.

The formula that can be used is the following :

Where Ct is the cash flow to be received at time t; PV is the present value of the asset producing expected future cash flows, Ct in years 1 through n; K is the investor's expected rate of return (the Yield to Maturity)

Of course, the Yield to maturity is not that simple to calculate and is generally computed into financial calculator. However, it is possible to calculate it approximately through a Trial-and-Error process by plugging various interest rates which, in the end must bring us to a price equals to the PV of the bond.

However, using these concept, there are a few important limitations that comes with it. First, the yield to maturity do not take into accounts the taxes that an investor pays on the bond. Then, these calculations are meant to estimate and are not necessarily reliable. Actual return depends on the price of the bond which can fluctuate according to market and economic features. This is more significant with the current yield but, can be significant as well with the yield to maturity.

**23.01.2018**

**Atty Gonenc Yay, LL.M**