Bond Definition
Learn more about what a bond is as it relates to business.
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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.
Keep reading to find out more about the definition of a bond, the advantages and risks of bonds, and how issuing bonds can help your corporation.
What is a Bond?
As we mentioned above, in business, the bond definition is similar to that of an IOU. When you buy a bond, you’re lending money to a business. In exchange, the business promises to pay you 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. We’ll take you through each one.
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 you’re an entrepreneur and these sound like things that your business could use help with, you might consider whether debt financing is right for you. We can help you form a corporation quickly and easily in virtually any state with our Corporate Formation Service. Once you’ve got an entity formed, you can make decisions about how best to finance your company.
Bond Advantages and Benefits
Bonds can provide investors with a predictable income stream. Unlike equity securities that may lose value, investors know what the exact value of a bond will be. 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
Protect yourself and do your homework before buying a bond. If you’re thinking about issuing bonds for your company, be sure to consider these risks.
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.
We Can Help
Our Business Formation Services can help you create your legal entity quickly and easily. When you’re ready to raise money by offering bonds, our award-winning suite of business services can help keep you up to speed on business compliance. Take advantage of our Worry-Free Compliance Service and leave the business entity paperwork to us!
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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