So let's start with a little bit of terminology. Bonds are very simple instruments to understand. Sometimes people think that they're very complex things, but they're actually fairly simple. And so a lot of it has to do with the terminologies. So first bond is a contract, is a contract between a borrower and lender, and that contract is specifies the conditions for this contract. Basically says I'm taking from you this amount of money, I'm willing to pay this back at this point in time, this much, and then the bond will expire. Most bonds, there are exceptions, and we'll talk about that in a couple of minutes. But most bonds actually have an expiration date. And so the contract specifies when you pay, how much you pay, when the bond expires, and on, and on, and on. That contract is called the indenture. So if you ever hear the words the indenture of a bond, that is basically the contract, is very simple, that specifies, now, it's not that the contract is simple, it's very complicated. But it simply specifies the idea that there's a borrower and a lender, and the terms on which they agree. Now, there's something called the principal, and the principal is sometimes called the face value. And that is if you buy a bond, that face value, that principal is a nominal number. It tends to be 1,000 in the US, it could be any other number. But it's an important number in at least one thing. When you determine the coupons that you're going to pay, which we'll define in just a minute, those coupons are determined on the basis of that face value. So it's x percent of the face value of the bond. If you have, say, pay coupon 6% of the face value, that means that if the face value is 1,000, you'll be paying coupons of 6% of that $1,000. I'll give you a concrete example couple of minutes from now. But the face value is that nominal value of the bond, which in principal is the value that you get back on the maturity day. So you get coupons until the bond expires, and when the bond expires you get back that a face value of the bond. There's the interest rate and the coupon, these two things sometimes people talk about them interchangeably. Strictly speaking, the interest rate is the number to which you multiply the face value in order to determine how much you pay per year, or typical in the bond, per semester. And that is actually what it's called the coupon. And so again, sometimes these two things are a little bit interchangeable. But if you pay 5% of a face value of 1,000, then that means that on an annual basis you'll be paying those 50 over and over and over again until the bond expires. And again I'll give you an example in just a minute. But the interest rate and the cupon are important parts of the bond because they determine how much money you're going to put in your pocket over time. That is, semester after semester, year after year, up until the bond expires. And finally there's the maturity, which is very clearly specified in the indenture in the contract. And that says that were going to be paying coupons up until this point in time. And when that point in time arrives, then we're going to pay you the face value of the bond, which again, you know how it is. So a bond, and again, we'll get to these details in just a minute. But bond has perfectly predictable cash flows. You know when you're going to get money, and you know how much money you're going to get at each of those points in time. All of which are perfectly specified when you get paid, and how much you get paid. We may introduce a few terms a little bit later, but those are the main things to keep in mind so that we can use them in the rest of the of our discussion today. Now who can issue bonds an the answer to that is just about anybody. Of course, governments issue bonds, of course companies issue bonds, but other people can issue bonds. I have a cool example that I always like to offer, which is some of you may know David Bowie, a British rockstar that died a couple of years ago. He actually issued a bond. This is a guy who is a very well known artist, he sells a lot of albums, he has a back catalog that actually generates a lot of money. And one thing that you can do with the provision that you're going to be generating money in the future too. Is advanced me some money today, and I pledge this catalog that you're going to generate money to pay the coupons of a bond. So I think that this is a kind of an interesting example that just about anybody can issue a bond. As a matter of fact Michael Jackson also had issued a bond. So it could be governments, it could be companies, it could be anybody as a matter of fact, and the characteristic of the bond, well, that is specified in the indenture. And that's what we're going to next, that you can think of three types of bonds. In fact, there are many more, but the three of them are the plain vanilla, the basic ones. The ones that are by far the most widely use, are called coupon bonds, and coupon bonds are the idea that we mentioned before. Basically, you're paying coupons over time up until the maturity date. And only majority day, you pay a final coupon plus at the face value. As long as between the time that the bond is issued and the time that the bond expires. As long as you're paying coupons, that is generally referred to as a coupon bond. Now of course you have bonds that never pay coupons, and those are called zero-coupon bonds. The name actually suggest itself what it is. And that basically means that the only thing that you get if you buy one of these bonds, is basically the face value at the end. Now let's suppose that you buy a ten-year zero-coupon bond. And that basically is someone telling you 10 years down the road I'm going to give you $1,000. Well if someone is going to give you $10,000, 10 years down the road, obviously you would pay less than that today. And that is a typical characteristic of a zero-coupon bond is that they're always trading below face value. And they trade below face value because the difference of the price that you pay to buy the bond and the face value of the bond that you get until maturity. That is basically the return that you get overtime. So there are bonds that do not pay coupons and there's the opposite. The opposite is kind of curious because the opposite basically is a bond that pays coupons over and over and over and over again. But these are bones that don't have a maturity date, which means you never get the principal, you never get the face value back. In principal, these are infinite bonds. You commit to be paying these coupons time, after time, after time, after time. What typically happens, let me show you an example so that you believe that these bonds actually exist. They're not very popular, but that's an example from the UK. And what typically happens with these bonds is what this article is about, that the issuer be that a company, or be that a government. It's typically governments more than companies, but there are consoles issued by companies too. What typically happens is that companies or governments retire the bonds. So in principal they're going to be lasting forever. But at some point in time, as this article indicates, then the government says, let's retire the bond instead of keep paying coupon, after coupon, after coupon, after coupon. Which is buy whole bonds, and we stop paying those cupons. So as you see, there by far more standard coupon bond. But there are two opposites of that if you will. One that doesn't pay any coupons and the other that pays coupons but never returns the principal. And these three types of bonds, of course they coexist in the markets. There are other types of bonds that we could get into, they're a little bit more complicated. Yeah, they don't fit really well for what we want to do. The vast majority of governments, the vast majority of companies, tend to issue either coupon bonds or zero-coupon bonds. And that's the vast majority of bonds that you can buy in the market.
