Bond
Definition
A bond is a debt security in which the issuer owes the holders a debt and is obliged to pay them interest (referred to as the coupon) and/or repay the principal at a later date, termed the maturity date. Essentially, a bond acts as an IOU between the issuer and the investor. Bonds usually take the form of fixed-interest securities issued by governments, local authorities, or companies, but they can vary significantly:
- Fixed or Variable Interest Rates: Bonds can offer fixed coupon payments or adjustable rates that change with market conditions.
- Redeemable or Irredeemable: Some bonds have a defined maturity date (redeemable), while others do not (irredeemable or perpetual).
- Short-term or Long-term: The term to maturity can vary from short-term (less than 5 years) to long-term (over 10 years).
- Secured or Unsecured: Secured bonds are backed by specific assets, whereas unsecured bonds (often called debentures) are not.
- Marketable or Unmarketable: Bonds can be bought and sold on secondary markets, although some may not be as liquid.
Fixed-interest payments are usually made semi-annually but may also be credited upon the bond’s maturity. Upon maturity, the issuer repays the face value (par value) of the bond to the holder.
Examples
- Government Bonds: These are bonds issued by a national government and are often considered low-risk investments.
- Corporate Bonds: Issued by companies, these bonds generally offer higher interest rates than government bonds but come with higher risk.
- Municipal Bonds: Issued by local governments or municipalities, these funds are often used for public projects and can be tax-exempt.
- Zero-Coupon Bonds: These bonds do not pay periodic interest. Instead, they are issued at a discount to par value and mature at their face value.
- Convertible Bonds: These can be converted into a predetermined number of shares in the issuing company.
Frequently Asked Questions
Q1. What is a bond’s coupon rate? A: The coupon rate is the interest rate that the issuer of the bond commits to pay periodically to the bondholder. This rate could be fixed or variable.
Q2. How does the bond’s maturity affect its performance? A: Bonds with longer maturities typically have higher yields to compensate for the increased risk over time. Short-term bonds are less sensitive to interest rate changes.
Q3. Why would an investor choose a bond over stocks? A: Bonds typically offer more stable returns and lower risk compared to stocks. They provide regular income through interest payments and return of principal upon maturity.
Q4. What is the difference between secured and unsecured bonds? A: Secured bonds are backed by specific assets, reducing the risk of default for the bondholder. Unsecured bonds, also known as debentures, are not backed by assets and hence carry more risk.
Q5. Can bondholders convert their bonds into equity? A: Some bonds, known as convertible bonds, can be converted into a specified number of shares of the issuing company, offering potential for capital gains.
Q6. What happens if a bond issuer defaults? A: If the issuer defaults, secured bondholders may claim the specified assets, while unsecured bondholders may face partial or total loss of their investment.
Related Terms
- Debenture: An unsecured bond that relies on the creditworthiness and reputation of the issuer rather than being backed by specific assets.
- Yield: The return a bondholder receives on a bond, usually expressed as an annual percentage rate.
- Credit Rating: An assessment of the creditworthiness of a bond issuer, which affects the interest rate and the level of risk.
- Par Value: The face value of a bond, repaid by the issuer at maturity.
- Coupon Rate: The interest rate the bond issuer agrees to pay bondholders.
Online Resources
- Investopedia: Bonds
- U.S. Securities and Exchange Commission (SEC)
- Corporate Finance Institute: What is a Bond?
Suggested Books for Further Studies
- “Bonds: An Introduction to the Core Concepts” by Mark Mobius
- “The Bond Book” by Annette Thau
- “The Handbook of Fixed Income Securities” by Frank J. Fabozzi
- “Investing in Bonds For Dummies” by Russell Wild
- “Bond Markets, Analysis, and Strategies” by Frank J. Fabozzi
Accounting Basics: “Bond” Fundamentals Quiz
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