Bonds are the most common type of long-term
debt on a company’s balance sheet. Companies issue bonds when the amount of money they need is too big to get from one lender. By issuing bonds of $100, $1000 or $10,000, a large amount of long-term in
debtedness can be divided into many small investing units, thereby allowing more than one investor to participate in the loan.
Bonds have two elements, interest they pay on an annual or semiannual basis and a lump sum at the end. The contract that arises from the issueance of bonds is called a Bond Indenture.
When a company issues bonds they print a certificate. On that certificate is a rate of interest known as the stated, coupon or nominal rate which is usually expressed as a percentage of the face value of the bond. However, the bond’s price is not determined by the issuer but by the supply and demand of buyers and sellers in the marketplace.
If the bond sells for less than the face value, then it is issued at a ‘discount’, which means that the interest rate that the market demands is higher than the rate stated by the issuer. Like any discount, this means that the buyer gets the bond for a lower price, which is the difference between the present value at the market rate compared to the present value at the stated rate. When the bond sells for more than face value, the bond gets issued at a premium, which means the buyer buys the bond for more than face value.
Three major investment companies, DBRS, Moody’s Investors Service and Standard & Poor’s Corporation, issue quality rating on each new bond issue based on the company’s ability to pay back the bonds. This is not a recommendation on whether or not to buy or sell the bond since that depends on market prices or suitability for particular investors.
In order to encourage investment, a variety of bonds have been created with different features. Here are some of the bonds that exist in practice:
Secured Bonds: Backed by a pledge or some sort of collateral eg. Mortgage bonds
Debenture bonds: Unsecured, usually have a higher interest rate and are more risky eg. Junk bonds
Term bonds: Mature at a single date
Serial bonds: Mature in installments
Callable bonds: allow issuer the right to retire the bond prior to maturity.
Convertible bonds: convertible into other securities (such as shares) at a specified time after issuance
Commodity-backed bonds: redeemible in measures of a commodity such as barrels of oil or ounces of a rare metal
Zero-interest debenture bonds: sold at a discount that provied the buyer’s total interest payoff at maturity.
Registered bonds: Issued in the owner’s name and require the surrender of the certificate and the issuance of a new certificate to complete the sale.
Bearer or Coupon bond: Opposite of Registered, the sale is completed simply by delivery
Income bonds: Only pay interest if the company is profitable
Revenue bonds: Interest is paid from a specified revenue source.