What are bonds and their types

Well there is a way of earning money on the stock exchange by making loans to companies or to the government in the form of bonds. A bond is a promise to repay a sum of money at a certain interest rate and over a certain period of time.

Loans made to joint-stock companies are usually called debentures while loans made to the government are called government stocks.

Unlike shareholders, debenture holders are not members of the company in question. They do not share the members’ risks; they receive a regular income from their investment and take precedence over the shareholders if the company is liquidated – that means, debenture holders are paid before shareholders. This makes debentures a relatively safe form of investment.

Loans can be made to the government as well in order to finance its spending. Government stocks are repaid at a fixed future date (at maturity). In the meantime, their holders receive interests on their loans. The interests received on government stocks are known as the coupon.

Why do companies issue bonds? Let’s say a corporation needs to build a new office building or needs to purchase manufacturing equipment. Or maybe a city government needs to construct a new school or repair streets. Whatever the need, a large sum of money will be needed to get the job done.

One way is to borrow this money form a bank, but a generally less expensive way is to issue bonds. Bonds are issued by companies of all sizes. Bond-issuing companies are rated by private ratings companies such as Moody’s or Standard & Poors, for example, and given an ‘investment grade’ according to their financial situation and performance (AAA being the best, and C the worst, it’s nearly bankrupt).

Most bonds are bearer certificates, so after being issued (on the primary market), they can be traded on the secondary bond market until they mature.

For companies, the advantage of bonds issue over shares issue is that bond interest is tax deductible. In other words, a company deducts its interest payments from its profits before paying tax, whereas dividends to shareholders are paid out of already-taxed profits. On the other hand if debt increases financial risk also increases. Bond interest has to be paid, even if the year was without any profits from which to deduct it and the principal has to be repaid when a bond reaches maturity.

And why do governments issue bonds? Governments, of course, unlike companies, do not have the option of issuing shares. Consequently they issue bonds to reduce the money supply, they sell bonds to commercial banks, and withdraw the cash received from circulation; to increase the money supply they buy them back.

There are different types of companies’ bonds.

” Secured (mortgage) and unsecured (naked) debentures.If a company cannot repay the loans or pay the interest, the holders of secured debentures are automatically entitled to payment from the company’s assets. But holders of unsecured debentures are not automatically repaid from the company’s assets if the company is unable to pay in the usual way. They can of course go to court to recover their money, but are not treated differently from the shareholders. An unsecured debenture is basically no more than a promise to repay a loan.

” Registered and bearer debenturesThe holders of registered debentures are listed in a company register. These debentures can only be transferred in accordance with certain terms and conditions, and every transfer must likewise be entered into the register. A bearer debenture is an unregistered debenture which can be negotiated by just handing it over to the new holder.

” Redeemable and irredeemable debentures Redeemable debentures are repaid on a fixed date or within a certain period, often at a higher price than the issue price, which means some extra money for the holder. There is no fixed date for the repayment of irredeemable debentures; the loan is only repaid when the company is liquidated. However, holders of irredeemable debentures may ask the company to redeem them if it fails to keep up its interest payments.

” And there are also convertible debentures that can be exchanged for ordinary shares if a debenture holder wants.

There are also different types of government stocks that fall into three categories depending on the date of maturity:” Shorts: bonds to be redeemed in 7 years or less;” Mediums: bonds to be redeemed in a period of 7 to 15 years;” Longs: bonds to be redeemed more than 15 years from the date of issue. And in the end it’s necessary to say that the choice of bonds depends on readiness of an investor to risk.