PrivateBonds.com

We’ve all borrowed money, whether it is to purchase our first car, house or even the extension on our home. Now put that into the perspective of a corporation or government – where do their loans come from? Just like us they sometimes require capital to finance a new project or expand into new markets, so where do they get their capital from?

One of the ways they can achieve this cash injection is to raise the money by issuing bonds to a public market. In its simplest form, a bond is a loan for which the lender receives an agreed number of interest payments and in return, the issuer receives the capital that they need in order to finance their project. Here is a quick example to show how this works:

Bond Issuer -> Public Market -> Agree Terms -> Issuer Receives Funding -> Lender Receives Agreed Interest Payments.

The interest rate of a bond is quite often known as the coupon. The issuer not only has to honour the coupon, but also what is known as the maturity date which is when the issuer has to repay the investment (face value) back to the lender.

Here is another example for you to chew over:

You purchase a bond with the face value (investment amount) of $5,000, a coupon (interest rate) of 10%, and a maturity (repayment period) of 10 years.

Now if you do the math, this will mean you will receive $500 of interest for the next 10 years. After those ten years, you will then get your $5,000 back.

So you will have allotted $5,000 in interest over 10 years, plus the original $5,000 that you started with – not bad eh?

So now that you have an understanding of what bonds are, we can look more closely at their specific features.

First of all, bonds are debt they are not equity as like you get when you invest in stocks. When purchasing stocks you naturally become an owner of that corporation, with that come voting rights and a claim to future profits. When purchasing bonds however, as it is a debt, you become a creditor to the corporation or government that is issuing the bond. You also, as a bond holder, have a higher claim on the assets of the corporation/government in the case of bankruptcy. The advantage is that you have a lower risk but with that comes a lower return.

Finally, bond holders do not get a share of future profits as you do if you are a shareholder; you are only applicable for the original investment and the agreed interest repayment.

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