What Should I Look for in a Bond Prospectus?

A bond prospectus offers potential investors key information regarding investment in a given bond, which is a debt security by which an issuer borrows money from a bond holder with an agreement to repay the principal along with a specified amount of interest at preset intervals over a fixed period. When making investment decisions, investors can benefit from knowing what items to look for in a bond prospectus. Important variables of a bond in the prospectus include the maturity date, the credit rating, the interest or coupon rate, and yield to maturity. Additional elements to look for in a bond prospectus include whether there is an early redemption feature, whether the bond is insured, what the tax status of the bond is, and what the broker’s commission and fees will be. Analysis of all of these elements will help the investor to determine the true value of the investment and the extent to which the bond fits into the overall financial strategy of the investor.

The first item to look for in a bond prospectus is the maturity date, which is the date upon which the issuer will return the principal investment. Investors must consider whether they can tie up their funds for the full term of the bond. Some bonds have a call date feature that allows the issuer to repay the bond before the maturity date. If a bond is callable, it will potentially generate less than the expected interest if it is redeemed early. The bond’s coupon, or nominal interest rate, specifies the rate of interest that the issuer will pay the bondholder as long as the bond is open.

Bond credit ratings range from extremely high-risk, high-yield junk bonds to the low-risk, investment-grade variety. Independent companies, such as Moody or Standard & Poor, assign a credit score based on a letter scale from AAA to D. The highest credit rating for a bond is AAA, while a C or D grade calls into question the creditworthiness of a bond. Other credit indicators to look for in a bond prospectus are details of the issuer's plans for repayment of the bond and the directional outlook for the bond in the market. Insured bonds offer a higher level of protection in that an insurance company agrees to indemnify the principal and accrued interest if the issuer defaults.

Taxable bonds usually have higher interest rates to offset the taxation. Some municipal bonds are exempt from federal taxes, and on occasion, they are also exempted from state and local taxes, as well. United States Treasury bonds are exempt from state and local taxes. Investors should discuss the tax implications of the different bonds with an accountant or financial adviser to develop a personal strategy specific to the investor’s state and tax bracket.

A bond’s actual yield is the sum of the annual interest and the principal minus the broker’s commission, typically a percentage of the purchase, and any fees associated with the bond purchase. Investors should investigate these charges with their brokers prior to investing in a bond. The transactional category of the bond is another aspect to look for in a bond prospectus. A new-issue bond may be difficult to obtain due to competition from large institutions. Older, existing bonds are easier to obtain, either from the inventory of the brokerage or the market, but they cost more if the brokerage has to purchase the bond from the market.