Bonds
| Author | Mary Oliverio, Allie Miller |
| Pages | 54-57 |
Page 54
Bonds are debts to the issuers, whereas they are investments to buyers. Such debts appear on balance sheets of the issuing entities as long-term liabilities. Bonds provide a source of funds for the issuer and a payment to the buyer in the form of interest. Both bonds and stocks are referred to as securities, yet the two are different types of investments.
Page 55
Bonds are generally considered long-term obligations. Nevertheless, since there is trading in the secondary market for some types of bonds, it is possible to buy and sell such bonds at any time. Bonds are issued by entities seeking funds for a variety of reasons.
Corporations issue bonds often for expansion purposes, when they have determined that extension of their long-term debt obligations is a better strategy than to expand their ownership base through the issuance of additional stock. Corporations are frequently motivated to choose bonds over expansion of stock owners for two basic reasons: The cost of interest is deductible as a yearly expense, and there is no dilution of ownership through the extension of the company's liabilities.
The federal government issues bonds, along with short-term notes, for the expenditures required to operate the federal government and to pay off debt that is maturing. Municipalities and states issue bonds for capital expenditures that are perceived necessary to maintain the infrastructure of the entity. Such bonds provide funds to build local roads, stadiums, schools, and other public buildings.
Investors can choose from a wide variety of bonds. Among them are: corporate bonds, federal government bonds, municipal bonds, asset-backed bonds, mortgage-based bonds, and foreign government bonds. For each of these categories, there are variations. Additionally, there are bond funds related to government bonds, corporate bonds, and foreign government bonds. It is possible to buy bonds that are convertible into stock. The bond market is indeed complex and varied. For purposes of the discussion here, the focus will be on basic bond types: corporate, federal government, and municipal. There will follow a discussion of bonds as an investment for an individual.
In a corporation, the board of directors is responsible for making the decisions related to a bond issue including determining how much money is to be raised, what type of bond will be sold, what the maturity date will be, and what the interest rate will be. Corporations with sound credit standing are able to issue bonds without pledging assets. Such bonds are called debenture bonds, or unsecured bonds. Companies with low credit standing often issue secured bonds, for which specified assets have been pledged as collateral.
Corporations generally do not sell directly to the public; rather, they sell their entire issues to an underwriter, often an investment bank, which acts as "middleman" for the corporation and the bondholders. (Sometimes more than one underwriter participates in the sell of an issue, especially if the value of the issue is high.) The issuing company also engages a trustee, generally a bank or trust company, to monitor the sale to ensure that all the details of the bond indenture are honored by the underwriters.
The contract for a purchase of bonds is called a bond indenture, which provides a description of the bond issue as well as the rights of both the buyer and seller. The buyer, for example, may have the right to convert a bond into stock. Sellers often state options, which modify the basic agreement. For example, a common option is the right to retire a bond before its maturity date. Such bonds are called callable bonds. Before the possibility of paperless transactions, bond certificates were issued, but now transactions tend to be book entries only.
Bonds have a predetermined rate of interest called the...
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