Understanding Bonds For Beginners Part One
If you were paying attention in your economics class, you might have heard the phrase “stocks and bonds” thrown around a few times. Stocks and bonds are both securities (a security is a negotiable “instrument” that represents financial value), and thus both stocks and bonds can be used to finance a company and company activities. However, there are major differences between stocks and bonds. A bond can loosely be defined as a contract to repay borrowed money along with interest at set dates. An authorized issuer will owe holders a debt, and most of the time if you are issuing a bond you will have to pay interest and the principal at a later date. This later date is called maturity. So, you can see that a bond is much like a loan, the issuer is the borrower, the holder is the lender (the creditor) and the coupon is the interest. Bonds are repaid at fixed intervals over a period of time. Stocks and bonds are different due to the fact stockholders share a fraction of ownership in the business, whereas bondholders are creditors to the business. Another difference between stocks and bonds is that bonds usually have a set time span in which the bond will mature, whereas stocks have the capacity to be outstanding indefinitely. Bonds can be issued by credit institutions, companies, and public authorities. The most common way to issue bonds is through a process called underwriting. This is when one or more banks buys an entire issue of bonds from an issuer and re-sells them to investors. People called bookrunners arrange this, talking directly with investors and advising the bond issuer about the price and timing of the bond issue. All bonds have many of common features. A bond will have what is called a nominal (principal or face) amount, which is the sum of money on which the issuer pays interest. A few types of bonds can be redeemed for a different amount than what they were issued for and may be linked to performance of certain assets like a stock index, foreign exchange or a fund. This can sometimes result in an investor getting less or more than her original investment when the bond matures. To be continued in part two Mallory Megan works for Rapid Recovery Solution and writes articles on commercial collection agencies. |