What is bond?
Definition
A bond is a fixed income instrument that represents an investor's loan to a borrower (usually a corporation or government). A bond can be considered an IOU. between the lender and the borrower including the details of the loan and its payments. Bonds are used by corporations, municipalities, states, and sovereign governments to finance projects and operations. The bondholder is the debtor or creditor of the issuer.
Bond details include the end date by which the principal of the loan must be paid to the bondholder and typically include provisions for fixed or fixed interest payments to be made by the borrower.
The Issuers of Bonds
Governments (at all levels) and businesses often use bonds to borrow money. The government must fund roads, schools, dams or other infrastructure. The sudden costs of war may also require fundraising.
Likewise, corporations often borrow to develop their businesses, purchase goods and equipment, execute profitable projects, research and develop, or hire employees. The problem with large institutions is that they often need more money than the average bank can provide.
Bonds provide a solution by allowing multiple individual investors to take on the role of lenders. Indeed, the public debt market allows thousands of investors to lend out just as much capital as they need. In addition, the market allows lenders to sell their bonds to other investors or buy bonds from other individuals, long after the original issuer has raised capital.
How Bonds Work
Bonds are fixed-income securities, a familiar asset class alongside equities and cash. Many bonds are publicly traded, but some are only traded privately or over-the-counter. Borrowers issue bonds directly to investors to raise money for projects, operations, or to refinance debts. The bond includes the loan terms, interest payments, and maturity date. The coupon represents part of the bondholder's return for loaning funds to the issuer. The coupon rate determines the payment. Most bonds start at $1,000 and market price depends on credit quality, length of time until expiration, and coupon rate in current interest rates. When the bond matures, the face value is paid back. Initial bondholders can sell to other investors. A bond investor can sell before maturity. Borrowers may buy back bonds if rates drop or credit improves to issue new bonds cheaper.
Gist
Bonds are units of corporate debt issued by companies and securitized as marketable assets.
Bonds qualify as fixed income instruments because bonds traditionally pay fixed interest rates (coupons) to debt holders. Variable or floating interest rates are also quite common nowadays.
Bond prices are negatively correlated with interest rates: when interest rates rise, bond prices fall and vice versa.
A bond with a maturity date at which the principal must be repaid in full or there is a risk of default.