All About Bonds

In finance, a bond is some sort of a debt security, where an authorized issuer owes the holders a debt and, depending on the legal terms of the bond, is forced to pay interest (the coupon) and/or to repay the main value at a later date, called maturity. A bond is simply a formal contract to repay borrowed money with interest at constant intervals.

Thus a bond is similar to a loan: the issuer is the borrower (debtor), the holder is the lender (creditor), and the coupon is the form of interest. Bonds give the borrower external funds to finance long-term investments, or, in the case of government bonds, to finance running expenses. Certificates of deposit (CDs) or commercial paper are considered to be instruments of money market not bonds. Bonds must be paid back at constant intervals over a period of time.

Bonds and stocks are both securities, but the main difference between the two is that stockholders have an equity share in the company (i.e., they are owners), whereas bondholders have a creditor share in the company (i.e., they are lenders). Another difference is that bonds usually have a defined maturity, after which the bond is exchanged, whereas stocks may be stay indefinite. An exception is a consol bond, which is a perpetuity (i.e., bond with no maturity)


Issuing bonds 

Bonds are created by official authorities, credit institutions, companies and supranational institutions in the primary markets. The most common process of creating bonds is through underwriting, where one or more securities firms or banks, forming a syndicate, buy an entire lot of bonds from an issuer and re-sell them to investors. The security firm takes the risk of probable failure in selling on the issue to end investors.

On the other side government bonds are typically auctioned. In reality, the current financial crisis tested the willingness of the securities firms to actually perform underwriting. Bookrunners arrange Primary issuance, so they arrange the bond issue, have the direct contact with investors and act as advisors to the bond issuer in terms of timing and price of the bond issue. The bookrunners ability to underwrite must be discussed prior to opening books on a bond issue as there may be limited desire to do so.


Bond indices 

Many bond indices exist in order to manage portfolios and measure performance, just like the S&P 500 or Russell Indexes for stocks. The most famous American benchmarks are the (ex) Lehman Aggregate, Citigroup BIG and Merrill Lynch Domestic Master. The major amount of indices are parts of families of broader indices that are used to measure global bond portfolios, or may be further subcategorized by maturity and/or sector for managing specialized portfolios.



ABOUT THE AUTHOR 

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