What’s A Bond?

The next time you turn on a water faucet, drive down a newly paved road, read about a company expanding its operations, or drop you kids off at school, there’s a good chance that bonds played a part in making each of these a reality. Even larger than the stock market, the bond market is the largest securities market in the world and plays a vital role in the global economy and in our everyday lives.

A bond is a loan that the lender makes to the borrower. Governments, municipalities, corporations, federal agencies, and other entities issue bonds when they need capital to finance specific projects or general operations.

Like a loan, a bond pays a specified interest rate over the life of the bond and repays the principal amount at a stated time. The timing of principal payments can vary greatly depending on the type of bond being issued. Obligations similar to bonds can also be called bills, notes, certificates, leases, debt securities, or debt obligations. For simplicity sake, we refer to all of these as “bonds.”

Types of Bonds

Bonds generally fall into one of three categories:

Government Bonds

If you buy a government bond, you’re lending the government money. “Government bonds” is a general term
that encompasses a wide range of bonds issued by a variety of governmental entities.

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Corporate Bonds

Corporations issue bonds to fund new business ventures, expand operations, and purchase equipment. 

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Securitized Debt

In recent years, a process known as “securitization” has become increasingly popular. In this process, cash flows from various types of loans (e.g., mortgages, credit cards, car loans, etc.) are bundled (or pooled) together and sold to investors as securities.

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Risk

All investments carry some degree of risk, which is a major factor in determining an investment’s return. A good rule of thumb is the higher the risk, the higher the return.

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Public Offering vs. Private Placement

Issuers have two options for accessing funding, a public offering or a private placement. Each of these options has distinct advantages or disadvantages that may affect funding costs and/or the timing of a bond issue.  

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Costs of Issuance

In addition to the project costs that are intended to be financed with the bond proceeds, costs/fees are also incurred during the bond sale process. 

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