A bond is a formal contract for an issuer to borrow money from a lender and then pay it back at an agreed maturity date. The contract may call for coupon interest to be assessed and paid periodically, or in the case of a zero-coupon bond, the interest may be initially deducted from the loan proceeds and paid back entirely at maturity. You can purchase a bond directly from the issuer or buy one in the secondary market of bond holders. The secondary market is composed of exchange-traded bonds – they trade through institutions like the New York Stock Exchange – and bonds purchased over-the-counter directly from the inventories of bond dealers.
Select a bond issuer. There are many issuers in the bond market. They include issuers of government bonds, corporate bonds, municipal bonds and international bonds. Become familiar with the rules and conventions surrounding the marketplace for each type of bond issuer, including pricing conventions and settlement procedures.
Select the quantity of individual bonds desired. Most online bond dealers will display a range of bonds available from each type of issuer. Each bond will list its own characteristics, such as interest rate (termed the coupon rate), face value, cost per bond, and the amount of time until the maturity date. A bond’s face value is the principal amount one receives at the maturity date. For instance, U.S. Treasury bonds have a $1,000 face value.
Calculate the clean (without accrued interest) purchase amount. Bond prices vary, depending on the interest rate paid and the current marketplace rate of interest for similar bonds. The prices are quoted in percentages which must be multiplied by a trade factor to equate the quote value with the cash value. For instance, U.S. Treasury bonds have a trade factor of 10. A price quote of 99.75 must be multiplied by 10 to give the clean price per bond: $997.50.
Calculate the gross proceeds. This is the clean price per bond times the number of bonds purchased. Bond orders are usually quoted in terms of a face value. An order for 20 U.S. Treasury bonds would specify $20,000 face value for the lot. In our example, the gross proceeds would be 20 times $997.50, or $19,950.
Calculate the net proceeds by adding accrued interest and transaction costs. The accrued interest is the amount of coupon interest that has accumulated since the last interest payment; accrued interest must be paid by the buyer to the seller. Transaction costs vary by bond dealer and availability.