A quick look at some of the variations highlights this flexibility. The basic features of a bond— credit quality and duration—are the principal determinants of a bond's interest rate. In the bond duration department, companies that need short-term funding can issue bonds that mature in a short time period. Companies with sufficient credit quality that need long-term funding can stretch their loans to 30 years or even longer.
Perpetual bonds have no maturity date and pay interest forever. Better health and shorter duration generally enable companies to pay less in interest. The reverse is also true. Less fiscally healthy companies and those issuing long-term debt are generally forced to pay higher interest rates to entice investors.
One of the more interesting options companies have is whether to offer bonds backed by assets. Such bonds are known as collateralized debt obligations CDOs.
In consumer finance, car loans and home mortgages are examples of collateralized debt. Companies may also issue debt that is not backed by underlying assets. In consumer finance, credit card debt and utility bills are examples of loans that are not collateralized. Loans of this type are called unsecured debt. Unsecured debt carries a higher risk for investors, so it often pays a higher interest rate than collateralized debt.
Convertible bonds are another type of bond. These bonds start just like other bonds but offer investors the opportunity to convert their holdings into a predetermined number of stock shares. Finally, there are also callable bonds. They function like other bonds , but the issuer can choose to pay them off before the official maturity date.
Companies issue callable bonds to allow them to take advantage of a possible drop in interest rates in the future. The issuing company can redeem callable bonds before the maturity date according to a schedule in the bond's terms.
If interest rates decrease, the company can redeem the outstanding bonds and reissue the debt at a lower rate. That reduces the cost of capital. Calling a bond is similar to a mortgage borrower refinancing at a lower rate. The prior mortgage with the higher interest rate is paid off, and the borrower obtains a new mortgage at the lower rate. The bond terms often define the amount that must be paid to call the bond.
The defined amount may be greater than the par value. The price of bonds has an inverse relationship with interest rates. Bond prices go up as interest rates fall.
Callable bonds are more complex investments than normal bonds. They may not be appropriate for risk-averse investors seeking a steady stream of income. The advantages of callable bonds for issuing companies are often disadvantages for investors. There are many factors to consider before investing in callable bonds. For companies, the bond market clearly offers many ways to borrow.
The bond market has a lot to offer investors, but they must be careful. If bonds are sold on the public market, they can be traded - similar to shares. Some corporate bonds are structured to be convertible, which means they can be exchanged for shares at some point in the future. Bonds can be a very flexible way of raising debt capital. They can be secured or unsecured, and you can decide what priority they take over other debts. A bond always runs for several years and has a fixed maturity. The Securities and Exchange Commission classifies bond maturities as short term less than three years , medium term four to 10 years , or long term more than 10 years.
When the bond matures, the company pays back the money invested. The bonds run for 10 years. They could also sell the bonds to another investor before the end of the term.
A share is nothing more than a share in the ownership of a company. For example, if Very Big Corporation issues 1, shares, then one share represents a one-thousandth ownership stake in VBC. The owners of the shares are called shareholders, and they are co-owners of the company. Most types of shares come with voting rights, which means that shareholders get to vote on important company decisions, like the election of the board.
As with bond issues, companies sell stock to raise capital. They could issue bonds to raise the money, or they could finance the purchase through equity capital — issuing new shares. The newly issued shares would be available to purchase by existing shareholders of the company, or by new shareholders. The company offers the identical deal to all investors regardless of whether the individuals interested in buying just one bond each or corporations buying bonds.
The master loan agreement between the corporation and the investors is called a bond indenture. The indenture contains information that you would expect in any loan agreement such as: The amount of money the company is borrowing.
The interest rate the company will pay.
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