All About Bonds and How to Bank on Them
Bonds are an important constituent of modern financial markets. Just as an individual raises money through a loan or an advance from a bank, a company also raises funds for its use through the bond market. Bonds are instruments that are issued by a company for a specified period and rate of interest. Bonds are financial instruments that guarantee payment at the end of the period specified also called a maturity date.
Bonds are thus a form of IOU’s. These guarantee an investor repayment at the end of the maturity period. Bonds normally carry a rate of interest. The company assures to pay the bond holder the requisite sums due every quarter or half yearly or annually till the date of maturity. The investor can encash his bond at the end of the maturity period and get back his entire amount.
Bonds are different from equity which is the cost of a share of the company. It is subject to the vagaries’ of the market and performance of the company. Equity normally consists of shares of a specified value. This is referred to as face value and the value of the share may go up or down depending upon, market forces and the performance of a company. Holding equity means holding ownership of the company.
Bonds are not subject to market forces or the performance of the company and the agreed rate of interest will be paid by the company. Bonds are thus a regular source of income and preferred instruments to invest in by many people. Bonds can be
- Fixed Interest paying bonds
- Variable interest paying bonds
- Zero interest paying bonds.
Fixed interest paying bonds have no variation in the interest rate and the company agrees to pay the holder regular interest as announced in the prospectus. Variable interest bonds may be linked to the market rate of interest. Bonds that are zero interest bonds are normally sold at a discount. Their rate of sale is well below the face value of the bond. On maturity the holder is paid the money as per the face value of the bond.
Issue of bonds is highly regulated. Normally a bond is issued only after it is underwritten. It means a financial group guarantees the payment on the bond. The underwriters could be the lead banker of the company or any other financial institution.
Bonds are tradable commodities and are listed on the stock exchange.The rate for a bond is quoted along with the shares daily by the stock exchange. Depending on the time period a bond after a couple of years may be available at a discounted rate as part of the interest has already been paid to the holder.
The Bond market is an excellent source of funds for a company. It is in real terms a debt that company incurs and the person who buys the bonds becomes the creditor. Failure to pay a bond can result in a class action suit with punitive damages.
Bonds are an excellent source of steady income. Many persons opt for bonds to supplement their retirement income.