Debt instruments function like financial contracts promising repayment of borrowed money with interest. Here’s a breakdown of their key features:
- Maturity:
- This refers to the specific date by which the borrower must repay the entire loan amount (principal). It’s like the finish line for the debt – the borrower has to settle the loan by this date.
- Term-to-Maturity: This represents the remaining time until a debt instrument matures. It’s constantly decreasing from the issue date until the maturity date. You can calculate it on any given date by considering the time difference between that date and the maturity date. Think of it as the countdown to repayment.
- Coupon: Imagine regular interest payments as coupons you clip off a bond certificate (in the past, physical certificates were used). These are periodic interest payments made by the borrower (issuer) to the lender (investor).
- Coupon Rate: This is the interest rate applied to the principal amount to determine the coupon payment. It’s usually expressed as a percentage. So, a higher coupon rate means a larger interest payment for the investor.
- Principal: This is the core amount borrowed by the issuer, also known as the par value or face value of the debt instrument. It’s the foundation of the loan agreement – the money you’re lending and expect back at maturity.
An Illustrative Example:
Let’s say you invest in a “GS CG2028 10% bond.” This translates to:
- Issuer: Central Government (GS stands for Government Security)
- Maturity: Year 2028 (The loan will be repaid in full by 2028)
- Coupon Rate: 10% (You’ll receive interest payments at this rate)
Since government bonds typically have a face value of Rs. 100 and pay interest semi-annually (twice a year), you’d receive Rs. 5 (10% of Rs. 100) every six months until the maturity date in 2028.
By understanding these features (maturity, coupon, and principal), you can make informed investment decisions when considering debt instruments.