What are Bonds…
Bond, in lament terms, is a formal contract to repay borrowed money at an agreed rate and at an agreed time. The interest rate on the bond is called the coupon. The issuer of the bond is the borrower also known as the debtor. The holder of the bond is the lender also known as the creditor. So when you buy a bond you are lending your money to someone or something. When you need to raise money, you issue a bond. The amount borrowed is referred as the face value of the bond (also called principal and nominal). The date on which the issuer is required to pay off the face value of the bond is called maturity date. Bonds are sometimes referred to as bills when it matures less than one year, notes when it matures between one and ten and bonds when it matures above ten.
Bonds are securities and are not considered to be money market instruments like Certificates of deposit (CDs) and commercial paper. They are usually issued through underwriting where one or more securities firms or banks form a syndicate, buying the entire issue of the bonds from the issuer and re-sell them to investors. Bonds are issued in the primary markets by public authorities, credit institutions, companies and supranational institutions.
Here are some types of Bonds.
Asset-backed securities are bonds whose interest and principal payments are backed by underlying cash flows from other assets (The stuff that has taken the global economy to its knees). Examples mortgage-backed securities (MBS’s), collateralized mortgage obligations (CMOs) and collateralized debt obligations (CDOs).
Bearer bond is an official certificate issued without a named holder often registered by a number to prevent counterfeiting, but may be traded like cash.
Book-entry bond is a bond that does not have a paper certificate.
Fixed rate bonds are bonds that have a coupon that remains constant throughout its life.
Floating rate notes (FRNs) are bonds that have a variable coupon that is linked to an interest rate index.
Inflation linked bonds are bonds in which the principal amount and the interest payments are indexed to inflation. The interest rate is normally lower than for fixed rate bonds with a comparable maturity examples are the Treasury Inflation-Protected Securities (TIPS) and I-bonds issued by the U.S. government.
Lottery bonds are bonds issued by a state (usually in European). Interest is paid like a traditional fixed rate bond, but the issuer will redeem randomly selected individual bonds within the issue according to a schedule.
Pacific Railroad Bonds are bonds issued by City and County of San Francisco. Interest income received by holders of municipal bonds is often exempt from the federal income tax and from the income tax of the state in which they are issued.
Perpetual bonds are bonds that have no maturity date.
Registered bonds are bonds whose ownership is recorded by the issuer, or by a transfer agent. It is the alternative to a Bearer bond. The difference is that the Interest payments and the principal upon maturity are sent to the registered owner.
Revenue bonds are bonds distinguished by its guarantee of repayment solely from revenues generated by a specified revenue-generating entity associated with the purpose of the bonds.
Senior bonds are the first bond holders in line to be paid.
Serial bonds are bonds that mature in installments over a period of time.
Subordinated bonds are bonds that have a lower priority than other bonds of the issuer in case of liquidation. In case of bankruptcy, there is a hierarchy of creditors. First the liquidator is paid, then government taxes, then the senior bond holders and then the subordinates. As a result, the risk is higher. Therefore, subordinated bonds usually have a lower credit rating than senior bonds and pay higher rates.
War bond are bonds issued by a country to fund a war.
Zero-coupon bonds are bonds that pay no regular interest. They are issued at a substantial discount to par value, so that the interest is effectively rolled up to maturity. The bondholder receives the full principal amount on the redemption date.
More to come