Bonds are issued in denominations of $1,000 and increments of $5,000 thereafter. This is called bonds' face, or par, value - the full amount of the loan to be paid back when the bond reaches maturity. Maturities on bonds range from 10 to 30 years. Bonds with maturities under 10 years are called notes.
The interest rate the bond pays is the percentage of par value returned to the bondholder in fixed, semiannual installments until the bond matures and the debt is retired; it represents the issuer's cost of borrowing money and the investor's reward for lending it. For example, if a $1,000 bond is paying a coupon rate of 12 percent per annum, this means the investor would receive $120 each year in interest until the bond matures.
The interest rate determines the actual price of the bond to the investor, and is influenced by several factors. The first is the demand to borrow money. When the demand by governments and corporations to issue public debt is high, the cost of borrowing that money goes up. When the demand is low, the cost goes down.
The second factor is the risk/reward ratio. The more risk assumed in buying a particular bond, the greater the reward (higher the interest rate) the investor expects to receive.
Anticipated changes in the rate of inflation over the long haul one way investors have of assessing the risk/reward ratio. A less speculative method of assessing the risk/reward ratio is to look at a bond's credit rating. This is a letter rating, or grade, used by independent services such as Standard & Poor's and Moody's to gauge the issuer's potential to repay the loan in the future. Ratings are based on the financial stability of the issuer, which these services continually monitor.
Because the federal government's debt obligations are viewed as being free of default risk, T-bonds are not rated by these services. They're judged to be the highest-quality bonds available, and serve as the benchmark against which all other bonds are rated and priced.
The higher the rating, the more stable the issuer, whose bonds are considered "Investment Grade." Likewise, the higher the bond's rating, the lower its interest rate generally will be; there is no need for such high-caliber issuers to pay more to borrow money, due to their sound financial footing. Issuers of lower-rated and unrated bonds such as "junk" bonds, on the other hand, will tend to offer higher rates in order to entice investors, particularly those of the "no guts, no glory" stripe.
