BONDS

 

A bond is simply a loan taken out by a company. Instead of going to a bank, the company gets the money from investors who buy its bonds. In exchange for the capital, the company pays an interest coupon, which is the annual interest rate paid on a bond expressed as a percentage of the face value. The company pays the interest at predetermined intervals (usually annually or semi-annually) and returns the principal on the maturity date, ending the loan.

Unlike stocks, bonds can vary significantly based on the terms of its indenture, a legal document outlining the characteristics of the bond. Because each bond issue is different, it is important to understand the precise terms before investing. In particular, there are some important features to look for when considering a bond.

Maturity.

This is the date when the principal or par amount of the bond is paid to investors and the company's bond obligation ends. Therefore, it defines the lifetime of the bond. A bond's maturity is one of the primary considerations an investor weighs against their investment goals and horizon. Maturity is often classified in three ways:

• Short-term: Bonds that fall into this category tend to mature within one to three years
• Medium-term: Maturity dates for these types of bonds are normally around ten years
• Long-term: These bonds generally mature over longer periods of time

Secured/Unsecured.

A bond can be secured or unsecured. A secured bond pledges specific assets to bondholders if the company cannot repay the obligation. This asset is also called collateral on the loan. So, if the bond issuer defaults, the asset is then transferred to the investor. A mortgage-backed security is one type of secured bond backed by titles to the properties of the borrowers.

Unsecured bonds, on the other hand, are not backed by any collateral. That means the interest and principal are only guaranteed by the issuing company. Also called debentures, these bonds return little of your investment if the company fails. As such, they are much riskier than secured bonds.

Liquidation Preference.

When a firm goes bankrupt, it repays investors in a particular order as it liquidates. After a firm sells off all its assets, it begins to pay out its investors. Preferential debts are debts that must be paid first, followed by subordinated debts. Stockholders get whatever is left.

Coupon.

The coupon amount represents interest paid to bondholders, normally annually or semi-annually.  

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