Bonds are promissory notes issued by either the government or a business in order to raise capital. Offering bond notes is a great means to raise funding because it looks to borrow money externally in order to expand cash supply without putting pressure on current cash reserves.
Bondholders are the parties who offer cash in exchange for the bond. When bonds are offered the issuing agency of the bond agrees to make both interest and principal payments to the bondholder on designated dates; it is a win-win situation if the terms are right.
Using bonds to raise capital differs from other loans and securities in the fact that bonds are long term contracts and the bondholder is considered a lender. This role differentiates bondholders from stockholders because while they have an interest in the company, they do not possess any kind of ownership like a stockholder would. Bondholders are simply providing funding for which they will receive interest in return.
Traditionally when people hear the word “bond” they immediately think of savings bonds, but in reality there are several variations of bonds issued either by a government unit or a corporate business. Here’s a brief run-down of the various kinds of bonds:
These are issued by the US Treasury Department and are also referred to as US savings bonds. These bonds are issued at 50% of their par, or also known as face value, and accumulate interest over the specified time of the bond. Bondholders who hold the bond for the designated time period attributed to the bond can expect the par value amount to be paid in full upon maturity.
This is a type of bond which involves at least three parties. The bond to be issued is contracted by an agency on the behalf of another representative party, known as the obligee. It certifies that the representative party will fulfill bond obligations to the bondholder. If the obligee defaults, the surety bond is insured to guarantee the obligation is paid to the bondholder.
Bonds issued at a premium are bonds which are sold at a market price higher than the bond’s face value because interest rates are currently below the stated coupon rate of interest. This is an evening technique used to level the platform and make bonds attractive for investment.
Bonds issued by state or local governments are commonly are called municipal bonds and are often referred to as “munis”. Municipal bonds are advantageous because they are exempt from federal taxes and if the holder resides in the issuing state, state taxes are also exempt for those bondholders. Municipal bonds’ interest rates are lower than other bonds, but do contain default risks because municipal bonds are subject to interest, callable and market rate risks.
The bonds issued by the US government are called treasury bonds. These bonds are quite safe and extremely low in risk which is a significant advantage. The one big drawback in treasury bonds is that their prices tend to decline when interest rates rise which creates a level of risk.
These are bonds issued by a country’s government in the country’s denomination of money. Government bonds are essentially risk free because the administration guarantees repayment of the money borrowed.
Different kinds of bonds have common features, but each kind of bond has unique attributes which are bond-specific. Before purchasing any kind of bond it is always a good idea to recognize any potential risk and understand the terms in which your money will be repaid.