Bond is a certificate issued by a business company or government promising to pay back money it has borrowed. The issuer of the bond promises to return to the bondholder the principal (amount borrowed) when the bond matures (comes due) at some future date. Most bonds pay interest at regular intervals. Because the person who buys a bond is a creditor and not a stockholder, bonds enable businesses and other issuers to raise funds without enlarging the pool of owners.
How bonds are issued.
Bonds are usually issued in groups. Each bond represents a fraction of the amount being borrowed. A person could buy a bond of $1,000 denomination that is part of a $100,000 issue. This type of issue enables people of moderate means to invest, and enables businesses to obtain substantial funding. Many bonds are traded on stock exchanges.
Kinds of bonds.
There are several kinds of bonds. Mortgage bonds give the investor a claim on some or all of a company’s property. Such a claim, called a lien, is given as security in case the loan is not repaid when due. Debentures are bonds that are not protected by a lien. Collateral trust bonds are secured by property called collateral (often stocks or bonds) deposited with a trustee. Income bonds promise to repay principal but to pay interest only when there are earnings. Callable bonds may be redeemed by the issuing corporation under stated conditions before maturity. Serial bonds mature in relatively small amounts at stated intervals. Municipal bonds are issued by state or local governments. Inflation-indexed bonds protect bondholders from being repaid in dollars whose value has been reduced by inflation (rising prices). The amounts investors receive are adjusted to correspond to current market prices.
Bond ratings.
Bonds are assigned ratings by independent organizations, such as Moody’s Investors Service and Standard & Poor’s Corporation, based on their degree of risk. Risk is determined by how likely it seems that the issuer might default (fail to meet its obligations). The riskier a bond, the lower its rating. Because investment experts perceive large, established companies as low-risk, bonds issued by such companies usually have investment-grade ratings. These ratings mean that the companies pay lower interest rates to investors. Bonds with noninvestment grade ratings must offer a higher rate of interest to make up for their higher risk. Such bonds—also called high-yield bonds or junk bonds—have gained popularity among investors because their high interest rates often more than make up for the risk of default. Many companies issue such bonds to raise money for investing in new technologies.
