Bond Definition

A bond — also called a “debt security” — is similar to an IOU. Companies and governments issue bonds as a way to borrow money from investors. This guide explains more about what a bond is, the advantages and risks of bonds, and how issuing bonds can help a corporation. 

What is a bond?

As mentioned above, a bond is similar to a formal “IOU.” When someone buys a bond, they’re essentially lending money to an organization (such as a business or a government). In exchange, that organization promises to pay the lender an agreed-upon interest rate for a specified time. They also agree to repay the principal, also known as the face or par value of the bond, by a certain date. 

Types of Bonds

There are four primary categories of bonds sold in U.S. markets. This section explores each category.  

Corporate Bonds 

Corporate bonds are issued by companies. Sometimes, companies issue bonds rather than seek bank loans for financing certain projects or investments. In situations like this, a bond benefits both shareholders and the corporation.

Municipal Bonds 

Municipal bonds are issued by states and municipalities. One municipal bond advantage over other types of bonds is the potential tax benefit for investors. 

Government Bonds 

A government bond is a bond issued by the U.S. Treasury. The entire category of bonds issued by a government treasury is often called “treasuries.” Government bonds issued by national governments may be referred to as sovereign debt.

Agency Bonds

Agency bonds are issued by government-affiliated organizations. Agency bond examples include bonds issued by Fannie Mae and Freddie Mac, the U.S. Congress-created federal mortgage companies.

Why do companies and governments issue bonds?

Companies, governments, and municipalities that issue bonds are known as “issuers.” These entities commonly issue bonds for any of the following reasons:

• Sustaining operations
• Financing debt
• Funding capital investments

If an entrepreneur thinks these types of investments could be helpful, they’ll need to form a corporation. ZenBusiness makes that possible with its Corporate Formation Service. After the business is formed, the entrepreneur can make decisions about how to best finance their company.

Bond Advantages and Benefits

Bonds can provide investors with a predictable income stream. Unlike equity securities that may lose value, investors know the exact value of a bond. This is why bonds are sometimes called “fixed-income instruments.” Additionally, the interest from municipal bonds is generally exempt from federal income tax and may be exempt from state and local taxes. 

Bond Disadvantages and Risks

There are a few risks that come with owning bonds. These include:

• Credit risk: Credit risk occurs if the issuer fails to make interest payments on the bond
• Interest rate risk: Interest rate changes can affect a bond’s value
• Inflation risk: Inflation reduces purchasing power, which can impact investors who receive a fixed income from a bond interest
• Liquidity risk: Bonds don’t trade on securities exchanges like stocks, and investors may not be able to sell their bonds as easily as they want
• Call risk: Bond issuers sometimes “call” certain types of bonds (or pay the investor back the bond’s face value) before their maturity dates if interest rates decline
• Fraud risk: Because bonds aren’t sold on a registered exchange, one bond disadvantage is that bad actors can issue scam bonds 

If someone’s considering buying a bond, it’s prudent to do their homework to make an informed decision. Companies should also consider the risks before issuing bonds.

Bond Definition Summary

Bonds are debt securities that are issued by companies and governments and sold to investors. As with most debt, bonds have maturity dates, at which point the principal amount must be paid back in full.

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ZenBusiness Can Help

ZenBusiness offers a variety of Business Formation Services that can help entrepreneurs create a legal entity quickly and easily. They’ve also got a variety of services that can help businesses stay compliant, so they’re free to spend more time preparing to issue or purchase bonds with their Worry-Free Compliance Service.