Bonds are fixed-income instruments used by investors to provide loans to corporate or government borrowers (typically corporations or governments). A bond acts like an IOU between lender and borrower that includes information regarding repayment details of their loan agreement and payments due. Companies, municipalities, states and sovereign legislatures all utilize bonds for financing projects and operations while bond holders act as creditors of the issuer of these debt instruments.
Details regarding bond ownership usually include an end date when principal will be returned and terms regarding variable or fixed interest payments by borrowers.
The Issuers Of Bonds
Governments (at all levels) and corporations often issue bonds to raise cash. Legislatures use them to finance roads, schools, dams or other infrastructure projects while unexpected expenses such as war can require reserves be built up quickly.
Corporations also need capital to expand their business, buy property and equipment, embark on profitable projects, conduct research and advance development, recruit representatives or conduct recruitment drives – unfortunately though, large organizations typically require significantly more cash than can be provided by typical banks.
Bonds provide an effective solution by enabling many individual investors to serve as loan specialists. Indeed, public obligation markets allow thousands of investors to share in lending capital required. Furthermore, markets allow banks to sell or acquire bonds long after initial issuer has raised capital.
How Bonds Work ?
How Bonds Work Bonds, also referred to as fixed-income securities, are one of the main asset classes familiar to individual investors alongside stocks (equities) and cash equivalents.
Bonds issued by both corporates and governments may be publicly traded; others can be traded directly over-the-counter (OTC), between borrower and lender, or privately between borrower and bank.
Companies or entities looking for additional funds in order to finance new projects, maintain ongoing operations or refinance existing obligations may issue bonds directly to investors as a method for raising cash. A borrower (issuer) issues bonds that detail loan conditions such as interest payments that will be made and when reserves should be returned back (maturity date). Bondholders receive interest payments known as coupons as part of their return from loaning their assets over to an issuer; their rate of return (the coupon rate) determines which bond holders receive their assets back upon maturity date.1
Initial bond prices typically begin at par, or $1,000 face value per bond, though their market prices can depend upon several factors including issuer credit quality, timeframe until expiration and coupon rate relative to general interest rate climate at that moment in time. Once it reaches maturity, face value of bonds are usually returned back to borrowers as promised by issuer.
After receiving their bonds, most can be sold by the initial bondholder to other investors; that is, bond investors do not have to keep holding onto them until maturity date. Furthermore, it may be purchased back by the borrower in case interest rates decrease, or their credit has improved enough that new bonds may be issued at lower costs.