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Investment - Introduction to Debt Securities
Debt securities, bonds, and fixed-income securities are synonymous terminology, and they can be issued by enterprises and governments.
Companies and governments raise external cash to finance their operations. In the previous module, you learned that one method firms raise capital is by issuing stock securities. Another way that both corporations and governments may raise capital to finance operations is by borrowing through the issuing of debt securities, sometimes referred to as bonds.
In fact, debt securities, or bonds, represent a loan between the borrowing corporation or government and the lending investors.
In exchange for the use of the borrowed money, the borrowing corporation or government undertakes to pay interest for the period of the loan and to repay the borrowed money in the future.
Because debt securities were historically issued with fixed interest payments, they are sometimes referred to as fixed-income securities in financial markets.
Bonds issued by firms are referred to as corporate bonds, and bonds issued by central governments are sovereign or government bonds. Local and regional government bodies may also issue bonds; in some markets, these bonds are referred to as municipal bonds.
Debt securities reflect a contractual obligation of the issuer to the holder of the debt security and are governed by a legal contract between the bond issuer and the bondholders. The legal document, which defines the fundamental aspects of the bond, is frequently referred to as the bond indenture or offering circular. In the event that the issuer does not satisfy the contractual commitments and make the promised payments, the bondholders often have legal remedies.
From the borrower’s perspective, paying interest is the expense of using borrowed money.
For the lender, receiving interest is compensation for opportunity cost and risk.
In some circumstances, bonds issued by certain central governments have particular names.
The following examples are names given to bonds by different countries' governments.
Bonds issued by the United States government are termed Treasury securities or Treasuries.
Bonds issued by the United Kingdom government are termed gilts
Bonds issued by the German government are called bunds.
Bonds issued by the French government are termed OATs (Obligations Assimilables du Trésor).
Features of Debt Securities
When small, private enterprises borrow money, they are likely to borrow money by taking out a loan straight from a bank. But when a large public or private corporation or a government borrows money, it normally does it by issuing bonds in financial markets. Companies and governments may have more than one issue of debt securities (bonds).
Each of these bond issues have different qualities associated to it, which affect the bond’s estimated return, risk, and value.
Par value
Par value refers to the amount that will be paid by the issuer to the bondholders when the bond matures.
Coupon rate
Coupon rate refers to the promised interest rate on the bond.
Maturity date
Maturity date refers to the date at which the loan terminates (bond matures).
Similar to the dividend payments for preferred stock mentioned in the previous module, a bond’s coupon payments are tied to the bond’s par value and the bond’s coupon rate. The annual interest owing to bondholders is equal to the product of the bond’s coupon rate and its par value.
The bond contract will stipulate the frequency and schedule of payments. Many bonds, such as government bonds issued by the US or UK governments, make coupon payments on a semiannual basis. Therefore, the amount of annual interest is half and paid as two coupon payments, payable every six months.
In fact, certain bonds may even pay interest weekly or monthly. Unlike certain loans for which the borrower pays back principal with each payment throughout the life of the loan, issuers of bonds normally only pay interest over the life of the loan and pay back the principal (par value) at the end of the bond’s life on the maturity date.
Debt securities are issued in a wide range of maturities, from as short as one day to as long as 100 years (or more). In fact, some bonds are perpetual, with no pre-specified maturity date.
But it is rare for new bond issues to have maturities of greater than 30 years. The life of the bond terminates on its maturity date, presuming that all guaranteed payments have been made.
Other elements may be incorporated in the bond indenture. For instance, to safeguard bondholders’ interests, it is typical for the bond contract to contain covenants, which are legal agreements that outline actions the issuer must undertake or is banned from executing. Bonds may also contain features that make them more attractive to the issuer or to investors.
These bond qualities will be examined in greater detail later in this section.
Although the term ‘bond’ may be used to designate any debt security, debt securities are referred to by different titles dependent on their length of maturity at issuance.
Bills are issued in terms ranging from a few days to 52 weeks.
Notes are issued in terms larger than 1 year up to 10 years.
Bonds are issued in terms larger than 10 years.
At issuance, investors acquire bonds directly from an issuer in the main market. The bondholders may later sell their bonds to other investors in the secondary market. When investors buy bonds in the secondary market, they are entitled to receive the bonds’ remaining promised payments, including coupon payments until maturity and principal at maturity.
Debt securities, bonds, and fixed-income securities are synonymous terminology, and they can be issued by enterprises and governments.
Companies and governments raise external cash to finance their operations. In the previous module, you learned that one method firms raise capital is by issuing stock securities. Another way that both corporations and governments may raise capital to finance operations is by borrowing through the issuing of debt securities, sometimes referred to as bonds.
In fact, debt securities, or bonds, represent a loan between the borrowing corporation or government and the lending investors.
In exchange for the use of the borrowed money, the borrowing corporation or government undertakes to pay interest for the period of the loan and to repay the borrowed money in the future.
Because debt securities were historically issued with fixed interest payments, they are sometimes referred to as fixed-income securities in financial markets.
Bonds issued by firms are referred to as corporate bonds, and bonds issued by central governments are sovereign or government bonds. Local and regional government bodies may also issue bonds; in some markets, these bonds are referred to as municipal bonds.
Debt securities reflect a contractual obligation of the issuer to the holder of the debt security and are governed by a legal contract between the bond issuer and the bondholders. The legal document, which defines the fundamental aspects of the bond, is frequently referred to as the bond indenture or offering circular. In the event that the issuer does not satisfy the contractual commitments and make the promised payments, the bondholders often have legal remedies.
From the borrower’s perspective, paying interest is the expense of using borrowed money.
For the lender, receiving interest is compensation for opportunity cost and risk.
In some circumstances, bonds issued by certain central governments have particular names.
The following examples are names given to bonds by different countries' governments.
Bonds issued by the United States government are termed Treasury securities or Treasuries.
Bonds issued by the United Kingdom government are termed gilts
Bonds issued by the German government are called bunds.
Bonds issued by the French government are termed OATs (Obligations Assimilables du Trésor).
Features of Debt Securities
When small, private enterprises borrow money, they are likely to borrow money by taking out a loan straight from a bank. But when a large public or private corporation or a government borrows money, it normally does it by issuing bonds in financial markets. Companies and governments may have more than one issue of debt securities (bonds).
Each of these bond issues have different qualities associated to it, which affect the bond’s estimated return, risk, and value.
Par value
Par value refers to the amount that will be paid by the issuer to the bondholders when the bond matures.
Coupon rate
Coupon rate refers to the promised interest rate on the bond.
Maturity date
Maturity date refers to the date at which the loan terminates (bond matures).
Similar to the dividend payments for preferred stock mentioned in the previous module, a bond’s coupon payments are tied to the bond’s par value and the bond’s coupon rate. The annual interest owing to bondholders is equal to the product of the bond’s coupon rate and its par value.
The bond contract will stipulate the frequency and schedule of payments. Many bonds, such as government bonds issued by the US or UK governments, make coupon payments on a semiannual basis. Therefore, the amount of annual interest is half and paid as two coupon payments, payable every six months.
In fact, certain bonds may even pay interest weekly or monthly. Unlike certain loans for which the borrower pays back principal with each payment throughout the life of the loan, issuers of bonds normally only pay interest over the life of the loan and pay back the principal (par value) at the end of the bond’s life on the maturity date.
Debt securities are issued in a wide range of maturities, from as short as one day to as long as 100 years (or more). In fact, some bonds are perpetual, with no pre-specified maturity date.
But it is rare for new bond issues to have maturities of greater than 30 years. The life of the bond terminates on its maturity date, presuming that all guaranteed payments have been made.
Other elements may be incorporated in the bond indenture. For instance, to safeguard bondholders’ interests, it is typical for the bond contract to contain covenants, which are legal agreements that outline actions the issuer must undertake or is banned from executing. Bonds may also contain features that make them more attractive to the issuer or to investors.
These bond qualities will be examined in greater detail later in this section.
Although the term ‘bond’ may be used to designate any debt security, debt securities are referred to by different titles dependent on their length of maturity at issuance.
Bills are issued in terms ranging from a few days to 52 weeks.
Notes are issued in terms larger than 1 year up to 10 years.
Bonds are issued in terms larger than 10 years.
At issuance, investors acquire bonds directly from an issuer in the main market. The bondholders may later sell their bonds to other investors in the secondary market. When investors buy bonds in the secondary market, they are entitled to receive the bonds’ remaining promised payments, including coupon payments until maturity and principal at maturity.
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