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Bond (finance)

In finance, a bond is a type of security under which the issuer (debtor) owes the holder (creditor) a debt, and is obliged – depending on the terms – to provide cash flow to the creditor (e.g. repay the principal (i.e. amount borrowed) of the bond at the maturity date as well as interest (called the coupon) over a specified amount of time).[1] The timing and the amount of cash flow provided varies, depending on the economic value that is emphasized upon, thus giving rise to different types of bonds.[1] The interest is usually payable at fixed intervals: semiannual, annual, and less often at other periods. Thus, a bond is a form of loan or IOU. Bonds provide the borrower with external funds to finance long-term investments or, in the case of government bonds, to finance current expenditure.

For other uses, see Bond.

Bonds and stocks are both securities, but the major difference between the two is that (capital) stockholders have an equity stake in a company (i.e. they are owners), whereas bondholders have a creditor stake in a company (i.e. they are lenders). As creditors, bondholders have priority over stockholders. This means they will be repaid in advance of stockholders, but will rank behind secured creditors, in the event of bankruptcy. Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks typically remain outstanding indefinitely. An exception is an irredeemable bond, which is a perpetuity, that is, a bond with no maturity. Certificates of deposit (CDs) or short-term commercial paper are classified as money market instruments and not bonds: the main difference is the length of the term of the instrument.


The most common forms include municipal, corporate, and government bonds. Very often the bond is negotiable, that is, the ownership of the instrument can be transferred in the secondary market. This means that once the transfer agents at the bank medallion-stamp the bond, it is highly liquid on the secondary market.[2] The price of a bond in the secondary market may differ substantially from the principal due to various factors in bond valuation.


Bonds are often identified by their international securities identification number, or ISIN, which is a 12-digit alphanumeric code that uniquely identifies debt securities.

Etymology[edit]

In English, the word "bond" relates to the etymology of "bind". The use of the word "bond" in this sense of an "instrument binding one to pay a sum to another" dates from at least the 1590s.[3][4]

Issuance[edit]

Bonds are issued by public authorities, credit institutions, companies and supranational institutions in the primary markets. The most common process for issuing bonds is through underwriting. When a bond issue is underwritten, one or more securities firms or banks, forming a syndicate, buy the entire issue of bonds from the issuer and resell them to investors. The security firm takes the risk of being unable to sell on the issue to end investors. Primary issuance is arranged by bookrunners who arrange the bond issue, have direct contact with investors and act as advisers to the bond issuer in terms of timing and price of the bond issue. The bookrunner is listed first among all underwriters participating in the issuance in the tombstone ads commonly used to announce bonds to the public. The bookrunners' willingness to underwrite must be discussed prior to any decision on the terms of the bond issue as there may be limited demand for the bonds.


In contrast, government bonds are usually issued in an auction. In some cases, both members of the public and banks may bid for bonds. In other cases, only market makers may bid for bonds. The overall rate of return on the bond depends on both the terms of the bond and the price paid.[5] The terms of the bond, such as the coupon, are fixed in advance and the price is determined by the market.


In the case of an underwritten bond, the underwriters will charge a fee for underwriting. An alternative process for bond issuance, which is commonly used for smaller issues and avoids this cost, is the private placement bond. Bonds sold directly to buyers may not be tradeable in the bond market.[6]


Historically, an alternative practice of issuance was for the borrowing government authority to issue bonds over a period of time, usually at a fixed price, with volumes sold on a particular day dependent on market conditions. This was called a tap issue or bond tap.

short term (bills): maturities under one year;

medium term (notes): maturities between one and ten years;

long term (bonds): maturities between ten and thirty years;

perpetual: no maturity period.

Government bonds

[10]

A , also known as a "supra", is issued by a supranational organisation like the World Bank. They have a very good credit rating, similar to that on national government bonds.

supranational bond

[10]

A is a bond issued by a government to fund military operations and other expenditure during wartime. It will often have a low return rate, and so can be bought due a lack of opportunities or patriotism.

War bond

are issued by corporations.[10]

Corporate bonds

(junk bonds) are bonds that are rated below investment grade by the credit rating agencies, because they are uncertain that the issuer will be able or willing to pay the scheduled interest payments and/or redeem the bond at maturity. As these bonds are much riskier than investment grade bonds, investors expect to earn a much higher yield.

High-yield bonds

A is a bond issued by a government or corporate entity in order to raise finance for climate change mitigation- or adaptation-related projects or programmes. For example, in 2021 the UK government started to issue "green bonds".

Climate bond

are bonds whose interest and principal payments are backed by underlying cash flows from other assets. Examples of asset-backed securities are mortgage-backed securities (MBSs), collateralized mortgage obligations (CMOs), and collateralized debt obligations (CDOs).

Asset-backed securities

are backed by cash flows from mortgages or public sector assets. Unlike asset-backed securities, the assets for such bonds remain on the issuer's balance sheet.

Covered bonds

are those 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, etc. The first bond holders in line to be paid are those holding what are called senior bonds. After they have been paid, the subordinated bond holders are paid. As a result, the risk is higher. Therefore, subordinated bonds usually have a lower credit rating than senior bonds. The main examples of subordinated bonds can be found in bonds issued by banks and asset-backed securities. The latter are often issued in tranches. The senior tranches get paid back first, the subordinated tranches later.

Subordinated bonds

are an agreement for public sector entities to pay back private investors after meeting verified improved social outcome goals that result in public sector savings from innovative social program pilot projects.

Social impact bonds

Fixed rate bonds are subject to , meaning that their market prices will decrease in value when the generally prevailing interest rates rise. Since the payments are fixed, a decrease in the market price of the bond means an increase in its yield. When the market interest rate rises, the market price of bonds will fall, reflecting investors' ability to get a higher interest rate on their money elsewhere—perhaps by purchasing a newly issued bond that already features the newly higher interest rate. This does not affect the interest payments to the bondholder, so long-term investors who want a specific amount at the maturity date do not need to worry about price swings in their bonds and do not suffer from interest rate risk.

interest rate risk

at Curlie

Bonds links

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