Bond

Bonds are issued by governments, agencies, municipalities and corporations. Key terms are face (par) value, coupon rate and frequency, maturity, day-count convention and any embedded features such as call, put, sinking-fund or conversion rights. Variants include zero-coupon bonds, floating-rate notes, inflation-linked bonds, convertibles and high-yield bonds. Bond prices move inversely to yields; sensitivity to rate changes is measured by duration and convexity.

Bonds are quoted at a clean price (excluding accrued interest) but settle at the dirty price, which adds interest accrued since the last coupon date. The buyer pays the seller that accrued interest at settlement and receives the full next coupon.

How funds account for bonds. Investment funds generally carry bonds at fair value, with prices sourced from pricing vendors, dealer quotes or exchanges according to the fund’s pricing hierarchy. Interest income is accrued daily using the bond’s day-count convention; many funds also amortize premiums and accrete discounts using the effective interest method, so that income reflects yield rather than coupon. Purchased accrued interest is recorded separately rather than added to cost. Corporate bonds are often Level 2 in the fair value hierarchy; distressed or illiquid issues can be Level 3.

Lifecycle events and pitfalls. Operations must process coupons, partial and full calls, sinking-fund redemptions, puts, conversions, exchange offers, defaults and restructurings. Frequent errors include wrong day-count or coupon schedules in the security master, coupon income booked without withholding tax, calls missed so a redeemed bond stays in NAV, accrual continued on defaulted bonds that should be placed on non-accrual, and stale vendor prices on thinly traded issues. Price challenges and tolerance checks catch many of these before NAV.

Example

A fund buys USD 1M face of a 5% semiannual corporate bond at a clean price of 98.50, 60 days after the last coupon (30/360). It pays USD 985,000 plus accrued interest of USD 8,333, and records the USD 15,000 discount for accretion to maturity.