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A bond is a debt security, in which the
issuer owes the holders a debt and is obliged to repay the principal and
interest (the coupon). Other stipulations may also be attached to the bond
issue, such as the obligation for the issuer to provide certain
information to the bond holder, or limitations on the behavior of the
issuer. Bonds are generally issued for a fixed term (the maturity) longer
than one year.
A bond is just a loan, but in the form of a security, although terminology
used is rather different. The issuer is equivalent to the borrower, the
bond holder to the lender, and the coupon to the interest. Bonds enable
the issuer to finance long-term investments with external funds.
Debt securities with a maturity shorter than one year are typically bills.
Certificates of deposit (CDs) or commercial paper are considered money
market instruments.
Traditionally, the U.S. Treasury uses the word bond only for their issues
with a maturity longer than ten years, and calls issues between one and
ten year notes. Elsewhere in the market this distinction has disappeared,
and both bonds and notes are used irrespective of the maturity. Market
participants use bonds normally for large issues offered to a wide public,
and notes rather for smaller issues originally sold to a limited number of
investors. There are no clear demarcations.
Bonds and stocks are both securities, but the difference is that
stock holders own a part of the issuing company (have an equity
stake), whereas bond holders are in essence lenders to the issuer.
Also bonds usually have a defined term, or maturity, |
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after which the bond is redeemed
whereas stocks may be outstanding indefinitely. An exception is a
consol bond, which is a perpetuity, a bond with no maturity.
Issuers
The range of issuers of bonds is very
large. Almost any organization could issue bonds, but the underwriting and
legal costs can be prohibitive. Regulations to issue bonds are very
strict. Issuers are often classified as follows:
Supranational agencies, such as the European Investment Bank or the Asian
Development Bank issue supranational bonds.
National Governments issue government bonds in their own currency. They
also issue sovereign bonds in foreign currencies.
Sub-sovereign, provincial, state or local authorities (municipalities). In
the U.S. state and local government bonds are known as municipal bonds.
Government sponsored entities. In the U.S., examples include the Federal
Home Loan Mortgage Corporation (Freddie Mac), the Federal National
Mortgage Association (Fannie Mae), and the Federal Home Loan Banks. The
bonds of these entities are known as agency bonds, or agencies.
Companies (corporates) issue corporate bonds.
Special purpose vehicles are companies set up for the sole purpose of
containing assets against which bonds are issued, often called
asset-backed securities.
Issuing
bonds
Bonds are issued by public authorities,
credit institutions, companies and supranational institutions in the
primary markets. The most common process of issuing bonds is through
underwriting. In underwriting, one or more securities firms or banks,
forming a syndicate, buy an entire issue of bonds from an issuer and
re-sell them to investors. Government bonds are typically auctioned.
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