Bonds are promissory notes, IOUs if you will, issued by a corporation or government to its lenders. They are usually issued in multiples of $1,000 or $5,000. The standard, or par, is $1,000. The bond indenture specifies the amount of interest to be paid at intervals, (usually every six months), over a specific length of time and the principal, (or original loan amount), to be repaid on the maturity date. A bondholder is a creditor; a shareholder is an owner.
Bonds are often secured, or backed by a specific pledged asset or other form of collateral. If the issuer defaults, bondholders have the right to liquidate its assets and recoup as much of their investment as they can. Here are some examples of secured bonds:
- Mortgage bonds
- Equipment trust certificates
- Collateral trust bonds
Retiring Corporate Bonds
Other bonds are unsecured and are known as debentures. The debt is backed solely by the good faith and credit of the borrower. You have already read about a special class of debentures, convertible debentures, which were simply referred to as "convertible bonds" until now.
TYPES OF CORPORATE BONDS
There are many types of corporate bonds:
- Guaranteed bonds: One company issues the bond and, as an added measure of security, another company guarantees to pay it if the issuing company cannot.
- Income bonds: Only the principal is promised; interest is paid only when the enterprise's earnings can cover the cost.
- Zero-coupon bonds: No interest, but the bond is issued at a deep discount and bought back at full par value.
- Speculative bonds: Also known as "junk bonds", these instruments have higher yields and are issued at lower prices than "investment-grade bonds" because of their higher risk.
Though these instruments are risky, they aren't necessarily "junk". Read more in the article Junk Bonds: Everything You Need to Know to learn when junk bonds are a suitable investment.
- Eurobonds: Issued and traded outside the country in whose currency they are denominated, and outside any one country's regulatory authority.
- Eurodollar bonds: A dollar-denominated eurobond. Eurodollars are U.S. dollars held by foreign institutions outside the United States.
- Yankee bonds: Dollar-denominated bonds issued in the United States by foreign companies.
- Repurchase agreements (Repos): Short-term - typically overnight - contracts in which the seller agrees to buy securities back at a specified time and at a higher price. Although structured as two offsetting sales, a repo is in reality a collateralized loan, as the buyer gives money to the seller then gets back that money with a premium that serves the same function as interest.
- Federal, or fed, funds: This is a misnomer: these funds are not lent to or from the Federal Reserve. Fed funds are the monies of private lenders held on reserve at Federal Reserve regional banks, and these monies are often lent from one of these private lenders to another overnight at the fed funds rate, the lowest rate offered between banks.
- Corporate commercial paper: Unsecured notes issued by corporations with a typical maturity of 30 days; companies use commercial paper to raise cash for current transactions, and many find it costs less than bank loans.
- Negotiable CDs: Federal Deposit Insurance Corporation (FDIC). These instruments are insured, fixed-rate time deposits. They are generally designed for those who are concerned about the safety of their principal and a require a predictable stream of cash flows. CDs tend to be large deposits, bouncing off the FDIC's $100,000 ceiling, - there is some secondary market.
- Bankers' acceptances (BAs): Primary and unconditional liabilities of the bank, used primarily as short-term good-faith financing to fund goods as they are being shipped from one country to another.
Repos, fed funds, commercial paper, negotiable CDs and BAs are considered money-market instruments and, as such, they are almost as liquid as cash.