SMK: Fixed Income

Bonds are simply debts/loans.

For example,

Bond Selling/Issuance AKA Borrowing

when you borrow $50K from a relative to start a business and promised to pay your relative $2K every year ($1000 every 6 months) as interest and to repay him/her $50K in full in 5 years on 1st Jan 2019, you are essentially selling/issuing a bond to your relative.

The coupon rate would be 4% ($2K divided by $50K)
The par value would be $50K. (ie. you return your relative $50K)
The maturity date would be 1st Jan 2019. (in 5 years time)

Zero Coupon Bonds AKA Paying Interest Later

Now your relative, on lending you the $50K, decides that he/she does not want you to stress over the interest during this period when you are building the business. He/She decides to delay the interest and says that you can just him/her back $60K on 1st Jan 2019.

Callable Bonds AKA Paying back Early to Save on Interest

Say you are quite confident in your business model and you feel that you can break even in 6 months and double your equity in 2 years, there is a good chance you don't feel too good on continuing paying that interest to your relative: they did do you a favour with the loan but they are not the ones running the business and facing the problems on a daily basis nor did they have any further input into the business. Besides, they have great value interest wise: 4% p.a. vs 0.05% p.a. from the banks.

So when you were borrowing the money, you negotiated a clause that you want to have the option of returning the $50K par value any time from the 2nd year onwards and not having to pay any further interest: call protection. Otherwise, maybe they are ok with forgoing the interest and you returning the full $50K any time.

Secondary Market AKA People Transferring your Loan

Now couple of years down the road, your business is booming and you are making good on the interest but you don't want to pay back the full $50K yet: business is doing great and you want to retain the capital to expand.

Your relative, by contrast, has a sudden need of cash (maybe didn't have an emergency fund) but just nice, another relative of his/her is interested and convinced to take over the loan albeit with a markup at $51K total.

Yields AKA Which is the Real Interest

Now the original relative had he/she held the bond to 1st Jan 2019 ie. maturity, reinvests/loan all the interest (5 years X $2K = $10K) you give him/her at the same interest. Take that and average over the original $50K that would be the yield to maturity.

The second relative should take the remaining interest (3 years X $2K = $6K) over the $51K he/she actually pays: $6K/$51K over 3 years will come to less than 4%.

Pricing & Risk AKA How Much is Your Loan Really Worth

Throughout this entire time, if your business falters or is seen to falter, your original relative will have a hard time convincing others to take over the loan and certainly at less than the original $50K.

Likewise, if your business is a sure thing or seen to be a sure thing, you could have originally proposed a lower interest at $1K (2% p.a.) and no one would have complained.

If your business collapses, then no one would have gotten back anything or everyone would have gotten back nothing.

Now if the banks are giving interest at 8% p.a., either you would have to be quite close to your relative or your relative would have had a hard time convincing himself/herself to lend you that money in the first place!