Why issue bonds instead of debt?
By issuing bonds, the company does not have to slice up its equity in exchange for investors' funds. Instead, it slices up its debt and sells it to investors in smaller units. Each investor holds these units and lends the firm money equivalent to the value of each unit.
1. Raising Capital: The most straightforward reason for issuing bonds is to raise money for various needs such as financing ongoing operations, expanding into new markets, or launching new products. Unlike equity financing, issuing bonds allows a company to raise capital without diluting ownership.
Bonds provide flexibility for a corporation: it can issue bonds of varying durations, value, payment terms, convertibility, and so on. Bonds also expand the number of investors available to the corporation. From an investor standpoint, bonds are generally less risky than stock.
A debt issue refers to a financial obligation that allows the issuer to raise funds by promising to repay the lender at a certain point in the future and in accordance with the terms of the contract. A debt issue is a fixed corporate or government obligation such as a bond or debenture.
In comparison, the main features of bonds are their fixed pricing (as opposed to floating) and the longer tenor. Unlike bank debt, the yield on bonds, therefore, does not change regardless of the interest rate environment.
Some of the disadvantages of bonds include interest rate fluctuations, market volatility, lower returns, and change in the issuer's financial stability. The price of bonds is inversely proportional to the interest rate. If bond prices increase, interest rates decrease and vice-versa.
Companies use the proceeds from bond sales for a wide variety of purposes, including buying new equipment, investing in research and development, buying back their own stock, paying shareholder dividends, refinancing debt, and financing mergers and acquisitions.
Bonds have some advantages over stocks, including relatively low volatility, high liquidity, legal protection, and various term structures. However, bonds are subject to interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk.
- Interest Payment: A significant disadvantage of bond issuance is that they are debt instruments. ...
- Default in Payment: If the issuer of bonds defaults in the payment of interest or principal, the bondholders may declare them bankrupt only if the former has not declared bankruptcy.
| Pros | Cons |
|---|---|
| Can offer a stream of income | Exposes investors to credit and default risk |
| Can help diversify an investment portfolio and mitigate investment risk | Typically generate lower returns than other investments |
Why do banks issue bonds?
Answer and Explanation: Commercial banks, like other business entities, too have liquidity needs. They issue bonds to get more capital to invest money. While this is not very usual for banks, they mat choose to do so when the deposits are difficult to come by.
Interest rates on government bonds are generally lower. Private loans on unsecured debt, on the other hand, are likely to attract a higher rate of interest. Corporate bonds are mostly somewhere in between – depending upon the reputation of the corporate.
If bond yields rise, existing bonds lose value. The change in bond values only relates to a bond's price on the open market, meaning if the bond is sold before maturity, the seller will obtain a higher or lower price for the bond compared to its face value, depending on current interest rates.
If the issuer defaults on payment of the bond, the bond price could plummet. If the issuer goes bankrupt (in the case of a company), the bond may become totally worthless, depending on the company's financial situation.
The people who purchase a bond receive interest payments during the bond's term (or for as long as they hold the bond) at the bond's stated interest rate. When the bond matures (the term of the bond expires), the company pays back the bondholder the bond's face value.
Bonds are often touted as less risky than stocks—and for the most part, they are—but that does not mean you cannot lose money owning bonds. Bond prices decline when interest rates rise, when the issuer experiences a negative credit event, or as market liquidity dries up.
- Values Drop When Interest Rates Rise. You can buy bonds when they're first issued or purchase existing bonds from bondholders on the secondary market. ...
- Yields Might Not Keep Up With Inflation. ...
- Some Bonds Can Be Called Early.
Historically, bonds have provided lower long-term returns than stocks. Bond prices fall when interest rates go up. Long-term bonds, especially, suffer from price fluctuations as interest rates rise and fall.
Companies issue bonds with long maturities for the same reason they do a lot of things: There's a market demand, and the goal of any business is to profit from that demand. And, when it comes to 100-year bonds, a group of investors does exist that has shown a strong appetite for this sort of debt obligation.
When interest rates rise or fall, investors in mutual funds and ETFs may be more likely to experience volatility in the performance of their investment, while investors in individual bonds who hold their bonds to maturity may not realize any impact.
How do investors make money off of bonds?
There are two ways to make money on bonds: through interest payments and selling a bond for more than you paid. With most bonds, you'll get regular interest payments while you hold the bond. Most bonds have a fixed interest rate. Or, a fee you get to lend it.…
Issuers sell bonds or other debt instruments to raise money; most bond issuers are governments, banks, or corporate entities. Underwriters are investment banks and other firms that help issuers sell bonds. Bond purchasers are the corporations, governments, and individuals buying the debt that is being issued.
Advantages of Issuing Bonds Instead of Stock
Interest on bonds and other debt is deductible on the corporation's income tax return while the dividends on common stock are not deductible on the income tax return.
Issuing bonds for a company has both favorable and unfavorable benefits and it certainly cannot concluded if it is more favorable. Bonds can have favorable effects in terms of lower cost of capital than equity since the bond interest rate is fixed an…
Cash is the most liquid asset possible as it is already in the form of money. This includes physical cash, savings account balances, and checking account balances.
