What is Bond? types of bonds


Bonds

A bond retains most of the features of a note. A bond is a security that obligates the issuer to make specified payments to bondholder. It represents a loan made by investors to the issuer. In return for his/her money, the investor receives a legal claim on future cash flows (interest plus face value) of the borrower. Each bond issue contains an indenture which is an agreement between the issuing company and the buyers of the bond known as bondholders. Contents of such agreement vary so it is important that for accounting and other purposes these agreements are studied thoroughly.

Following are some of the basic characteristics of a bond:

a.      It is a certificate that has an amount printed on it called a Par Value. Bonds are usually issued and sold in multiples of shs. 1,000.

b.      It has a rate of interest to be paid at some stated interval; annually, semiannually, quarterly, etc. The rate of interest printed on a bond is a stated rate of interest. It is also known as the coupon rate. Periodic interest payment is computed by taking:

Stated rate of interest*Par value*Time

c.      It has a date on which the bond is to be retired. This date is called the maturity date.

d.      It also has an issue date printed on it.

It is not necessary that bonds will be issued on this date although interest is computed effective this date.
Bonds are usually classified into the following categories:

Secured and unsecured bonds
Secured bonds are those attached to specific assets of the issuing firm. In the event of winding up bondholders have first charge over those assets. Unsecured bonds on the other hand are those that are not attached to any specific assets. They are also known as "naked" bonds. They are the most risky since in the event of winding up they are treated like any other unsecured creditors. Unsecured bonds became more active from the late seventies after the oil boom and they earned the term ‘junk bonds’.

Convertible and fixed bonds
Convertible bonds are those that may be converted into equity capital if conditions are favorable for such a conversion. Most venture capitalists will initially offer capital finance in the form of bonds that are convertible into equity at the option of the financier at a specified time period and under set conditions. These way financiers are protected and guaranteed a return in the early years of the business but they can also convert into equity holders when the business is growing and successful. Fixed bonds in contrast are not convertible and remain so until maturity.

Redeemable and irredeemable bonds
Where the bond agreement states that the issuing company has an option to announce the retirement of bonds for payment, then those bonds are redeemable. It is an option exercised when market rates of interest are significantly lower than the rate of interest provided by the bond. When such an option does not exist bonds are known as irredeemable bonds until maturity.

Registered and bearer bonds
Most bonds are registered where the name and address of the owner are recorded and maintained by the issuing company. In case of loss or theft a bondholder is protected and interest and the maturity value are payable to the registered owner at a closing date as determined by the issuing company. If bonds are not registered they are known as bearer bonds because interest and the maturity value are payable to a bearer.

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