One of the most common financial instruments, a bond is best understood as an instrument of indebtedness from the seller or issuer to the holder. Depending on the terms of the bond (and there are many types), the seller may be obligated to make interest payments (known as ‘yield’) to the bondholder, and/or to repay the initial price (known as the ‘principal’) at a later date (known as the ‘maturity’ date). You will often hear bonds referred to by their duration until maturity, for example ‘five-year bonds’, ‘ten-year bonds’, etc.
At its most basic level, a bond as an IOU. However, as with many instruments of finance, there are a number of flowery terms used around it which make a simple concept more complicated. The holder of a bond is the lender, or creditor. The issuer of a bond is the borrower, or debtor. The coupon is another word for any interest payments to be made, which may also be referred to as a bond’s ‘yield’. Bonds are often used by companies to provide additional external funds for long-term investments. They, along with bank loans, are the main methods that a company can debt finance (fund itself through debt). Governments also often issue bonds, usually to finance their expenditure.
While bonds and stocks are the most common financial securities, bonds differ from stocks in that stockholders hold an equity stake in the company, whilst bondholders have a creditor stake in the company (they are lenders). Bonds are usually considered a less risky option for investors than stocks, as they have absolute priority in getting repaid in the event of bankruptcy. Most bonds also last for a defined period of time, or maturity, until they are redeemed, while stocks theoretically last indefinitely. Bonds which do not expire are known as ‘irredeemable bonds’ or ‘perpetuities’ – bonds without maturity.
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