One way to finance a company’s investments is by taking a loan from banks and other institutions. Many corporations and individuals do this. Another way is by selling bonds to investors. Typically governments and big corporations resort to this route. There are of course several companies that take both the routes.
A Bond is a debt instrument requiring the issuer (borrower) to repay the lender (Investor) the amount borrowed plus interest over a specified period of time. The contract between the issuer and the bondholder, which sets forth all the obligations of the issuer, is called Bond Indenture.
The money collected by the issuer when a bond is issued (or sold) to the public, can be thought of as a kind of loan received by the issuer. In return, the issuer agrees to make specific payments to the bondholders, who are the lenders. The interest rate can be considered as the price of money. Interest rate is expressed in terms of a percentage of the original loan (face value of a bond) that has to be paid back.
A bond is a fixed interest financial asset issued by governments, companies, banks,public utilities and other large entities to raise funds. A ‘discount bond’ pays the bearer a fixed amount only at the ending date, while a ‘coupon bond’ pays the bearer a fixed amount over a specified interval (month, half-year, year, etc.) as well at the end date. Across the world,government bonds dominate the fixed income markets because of their size, liquidity and absence of credit risk factors which make these bonds relatively more sensitive to interest rates in comparison to other bonds (such as corporate bonds).
There are also several characteristics/features associated with a bond which helps us decide the type of a bond. They are – Issuer, Face Value, Term to Maturity, Coupon Rate, Embedded Options and Amortization.
Sinking Fund Provision – In certain bond indenture, there is a provision that’s calls upon the issuer to retire some amount of the outstanding bonds in the market, or as is more common, by creating a separate fund which calls the bonds on behalf of the issuer. Such provisions that enable retiring bonds over their lives are called sinking fund provisions.
Two very common terms associated with a bond is Yield and Duration which will be discussed in our later articles.