Everything that you need to know about a bond, a fixed-income instrument that represents a loan made by an investor to a borrower is mentioned in our blog expressly.

 

Table of Contents

What is The Meaning of Bond?

How do Bonds work?

Features of Bonds

Bond Categories

What are some different types of bonds?

What is an example of a bond?

 

What is The Meaning of Bond?

 

A bond is a fixed income instrument that represents a loan made by an investor to a borrower. A bond can be thought of like an IOU between the lender and the borrower that contains the details of the loan and its payments. Bonds are used by companies, municipalities, states, and independent governments to finance projects and operations. Bondholders are debtors or creditors of the issuer. 

 

Important Sections

• Bonds are corporate debt units issued by companies and securitized as tradable assets.
• Because bonds traditionally pay borrowers a fixed interest rate (coupon), the bond is called a fixed income instrument. Floating or floating interest rates are also quite common now.
• Bond prices are inversely proportional to interest rates: when rates rise, bond prices fall and vice versa.
• Bonds have maturity dates when the entire principal amount or risk of default must be repaid.

 

How do Bonds work?

Bonds are often referred to as fixed-income securities and, along with stocks and cash equivalents, are one of the main asset classes that individual investors are often familiar with. Many corporate and government securities are publicly traded; others are traded only over the counter or privately between borrower and lender.

 

Companies or other organizations can issue bonds directly to investors when they need to raise money to finance new projects, maintain ongoing operations, or refinance existing debt. The borrower issues a bond that includes the terms of the loan, the interest payments to be made, and the time the funds lent must be repaid. The interest payment is part of the return bondholders earn for lending their funds to the issuer. The rate of interest that determines the payment is called the coupon rate. Most bonds can be sold to other investors by the original bondholder after they are issued. In other words, a bond investor does not have to hold the bond until maturity. If interest rates fall or the borrower's credit improves, repurchase of bonds by the borrower is also common and can reissue new bonds at a lower cost.

 

Features of Bonds

Most bonds share some common key features, as you'll see in the examples below:

• Face value is the amount of money the bond will be worth at maturity; it is also the reference amount used by the bond issuer when calculating interest payments. For example, let's say one investor buys a bond with a premium of $1,090 and another investor later buys the same bond at a discount of $980. When the bond matures, both investors will receive the $1,000 face value of the bond.
• The coupon rate is the interest rate the bond issuer will pay on the bond's face value, expressed as a percentage. For example, a 5% coupon rate means that bondholders will receive 5% x $1,000 face value = $50 each year.
• Coupon dates are the dates on which the bond issuer will pay interest. Payments can be made in any range, but are standard semi-annual payments.
• The maturity date is the date the bond will mature and the bond issuer will pay the bondholder the face value of the bond.
• The issue price is the price at which the bond issuer originally sold the bonds.

 

Bond Categories

 

There are four main categories of bonds sold in the markets. But you can also see foreign bonds issued by companies and governments on some platforms.

 

• Corporate bonds are issued by companies. In most cases, companies issue bonds rather than seeking bank loans for debt financing because bond markets offer more favorable terms and lower interest rates.
• Municipal bonds are issued by states and municipalities. Some municipal bonds offer tax-free coupon income for investors.
• Government securities such as those issued by the US Treasury. “Bonds” for bonds issued by the Treasury with a maturity of one year or less; Bonds issued with a maturity of 1-10 years are called "promissory notes"; Bonds issued with a maturity of more than 10 years are called "bonds". All categories of bonds issued by a government treasury are often collectively referred to as "treasuries." Government bonds issued by national governments can be referred to as government debt.
• Agency bonds are bonds issued by government affiliates such as Fannie Mae or Freddie Mac.

 

How do bonds function?

 

Bonds are a type of security sold by governments and corporations as a way to raise money from investors. From the seller's perspective, selling bonds is therefore a way to borrow money. From the buyer's perspective, buying bonds is a form of investment because it entitles the buyer to a guaranteed repayment of principal as well as a stream of interest payments. Some types of bonds also offer other benefits, such as the ability to convert the bond into shares of the issuing company.

 

What are some different types of bonds?

 

Zero-coupon bonds do not pay interest over the term of the bond. Instead, their par value—the amount they pay back to the investor at maturity—is more than the investor paid when he bought the bond. Convertible bonds, on the other hand, give the bondholder the right to exchange their bonds for shares of the issuing company if certain targets are met. Many other types of bonds are available that offer features related to tax planning, inflation protection, and more.

 

What is an example of a bond?

 

As an example, consider the example of XYZ Corporation. XYZ wants to borrow $1 million to finance the construction of a new factory, but cannot get this financing from a bank. Instead, XYZ decides to raise the money by selling $1 million worth of bonds to investors. Under the terms of the bond, XYZ commits to paying bondholders 5% interest annually and semi-annually for 5 years. Each of the bonds has a face value of $1,000, so XYZ is selling a total of 1,000 bonds.

 

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