The Nature of Bonds


A bond is an instrument of indebtedness of the bond issuer to the holders; as such, it is often referred to as a debt instrument. A bond is a debt security under which the issuer owes the holders a debt and, depending on the bond terms, is obliged to pay them interest (the coupon) and/or repay the principal later, termed maturity. Interest is usually payable at fixed intervals (semiannual, annual, and sometimes monthly).

Bonds are issued by public authorities, credit institutions, companies, and supranational institutions in the primary market. Both individuals and companies can purchase bonds.

However, very often, the bond is negotiable, i.e., the ownership of the instrument can be transferred to the secondary market.

A bond from the Dutch East India Company A bond is a financial security that represents a promise by a company or government

A Bond from the Dutch East India Company A bond is a financial security that represents a promise by a company or government to repay a certain amount, with interest, to the bondholder.


Types of Bonds

The main categories of bonds are corporate bonds, municipal bonds, and U.S. Treasury bonds, notes, and bills, which are collectively referred to simply as "Treasuries." Two features of a bond – credit quality and duration – are the principal determinants of a bond's interest rate. Bond maturities range from a 90-day Treasury bill to a 30-year government bond. Corporate and municipal bonds are typically in the three to 10-year range.


Overview of the Instrument

A bond is a form of loan: the holder of the bond is the lender (creditor), the issuer of the bond is the borrower (debtor), and the coupon is the interest. Bonds provide the borrower with external funds to finance long-term investments or, in the case of government bonds, to finance current expenditures. Certificates of deposits (CDs) or short-term commercial papers are considered money market instruments and not bonds; the main difference is in the instrument's term length.

Bonds and stocks are both securities, but the major difference is that (capital) stockholders have an equity stake in the company (they are owners). In contrast, bondholders have a creditor stake in the company (they are lenders). Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is an irredeemable bond, such as Consols, which is a perpetuity, that is, a bond with no maturity.

Key Points

  • A bond is an instrument of indebtedness of the bond issuer to the holders. The issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and/or to repay the principal at a later date, termed the maturity.

  • Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure.

  • Bonds and stocks are both securities, but the major difference between the two is that (capital) stockholders have an equity stake in the company (i.e. they are owners), whereas bondholders have a creditor stake in the company (i.e. they are lenders).

Terms

  • Municipal Bonds – a bond issued by an American city or other local government, or their agencies.

  • Treasury Bonds – a U.S. Treasury bond is a government debt issued by the U.S. Department of the Treasury through the Bureau of the Public Debt, with a maturity of 20 years to 30 years.

  • Corporate Bonds – a bond issue by a corporation. It is a bond that a corporation issues to raise money effectively in order to expand its business.

Source: Boundless Finance, https://ftp.worldpossible.org/endless/eos-rachel/RACHEL/RACHEL/modules/en-boundless-static/www.boundless.com/finance/textbooks/boundless-finance-textbook/bond-valuation-6/understanding-bonds-64/index.html
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