Financial Management

What is a Bond? Why are they issued?

Bond

A bond is a lending agreement, known as a debenture, which outlines the terms and circumstances of the borrowing.

At a minimum, the debenture specifies the face value, interest rate, and length of the bond. The face amount represents the amount the bondholder is lending to the corporation. The contract interest rate is comparable to a rental charge that the corporation agrees to pay for the use of the lender’s money. It is expressed as a percentage per year, such as 6 per cent each year.

Lastly, the term is the number of years covered by the bond. The maturity date is when the corporation must repay bondholders the face value in full. None of the bond’s face value is repaid prior to the maturity date.

The issuer of the bond agrees to pay back the loan, with interest, over a set period of time. The terms of the loan are set forth in the bond indenture, which is a contract between the issuer and the bondholders.

Why Are Bonds Issued?

Often, a firm must raise funds from external sources for operations, acquisitions, or expansion. One method to accomplish this is by issuing shares. Investors give capital to a firm in exchange for shares of stock that represent their ownership stake.

Borrowing the funds and repaying them at a later period is a further option for raising capital. The corporation may obtain a loan for the whole amount required from banks and other traditional lending institutions.
Bonds, which are also a kind of debt, offer a further option for the firm. Bonds are loans issued by smaller lenders, including other businesses and private individuals. Typically, corporate bonds are issued in $1,000 increments.

A business may borrow from several smaller investors in order to raise the required amount of capital. Similar to how corporate stock is traded on the stock market, corporate bonds are exchanged on the bond market. They are long-term obligations for most of their existence and only become current liabilities one year before to maturity.

Bondholders are the individuals or entities that acquire bonds from a firm; they are effectively lending their money as an investment. The reason bondholders lend their money is that the firm pays them interest on the amount they lend for the duration of the bond’s tenure. Unlike investors, bondholders do not become owners of a business.

Conclusion

A Bond is a loan made by a lender to a borrower. In return, the borrower has agreed to pay back the loan. Lenders and borrowers are called the Bondholder and Bond Issuer, respectively. Bonds are also referred to as fixed-income securities.

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