Bonds

Bonds. As you can know companies finance most of their activities by way of internally generated cash flows. If they need more money they can raise them though issuing securities. Security is an instrument that signifies an ownership position in a corporation (in the form of a stock), a creditor relationship with a corporation or governmental body (in case of issuing bonds), or rights to ownership such as those represented by an option, subscription right, & subscription warrant.

Securities can be: - long term or short term - primary (like shares & bonds) & secondary (like options & warrants). Nowadays more & more companies prefer to issue their own bonds rather than borrow from banks. Because it's often cheaper: the market may be a better judge of the firm's creditworthiness than a bank, so it may lend money at a lower interest rate. This is evidently not a good thing for the banks, which now have to lend large amounts of money to

borrowers that are much less secure than blue chip companies. So what is a bond? Generally speaking, bonds are obligations that are issued by companies & government that are in essence promises to pay individuals or other investors-providers of funds - & they generally provide for a fixed rate of interest, that is a fixed repayment schedule, & a date in the future at which the money will be returned. They are different, for example, from stocks, which have an uncertain

future day-off, depending on a company's performance, & no final maturity date, so longs as the company remains active & solvent. As I started to compare shares & bonds it seems I should mention advantages & disadvantages of both of them. The advantage of debt financing (issuing bonds) over equity financing (issuing shares) is that bond interest is tax deductible. In other words, a company deduct its interest payments from its profits

before paying t ax, whereas dividends a repaid out of already-taxed profits. Apart from this "tax shield", it's generally considered to be a sign of good health & anticipated higher future profits if a company borrows. On the other hand, increasing debt increases financial risk: bond interest has to be paid even in a year without any profits, & the principal has to be repaid when the debt matures, whereas companies

are not obliged to pay dividends or repay share capital. Because of all these facts most companies prefer to issue both bonds & shares, thus a debt-equity ratio balances tax savings against the risk of being declared bankrupt by creditors. As for governments, they, of course, unlike companies, do not have the option of issuing equities. Consequently they issue bonds when public spending exceeds receipts from income tax,

VAT, & so on. Long-term government bonds are known as gilt-edged securities, or simply gilts, in Britain, & Treasury Bonds in the USA. The British & American central banks also sell & buy short-term (three month) Treasury Bills as a way of regulating the money supply. To reduce the money supply, they sell these bills to commercial banks, & withdraw the cash received

from circulation; to increase the money supply they buy them back, paying with newly created money which is put into circulation in this way. As I mentioned some kinds of bonds speaking on government bonds I feel I should proceed this topic. In terms of maturity bonds can be: 1. long-term (gilts or Treasure bonds) 2. short-term (like Treasury Bills) 3. middle-term. In forms of holders we distinguish between:

1. registered bonds 2. bearer certificate (whose owner is not registered with the issuer). According to the nature of the issuer there are: 1. government bonds 2. municipal bonds 3. industrial 4. commercial There can be a convertible bond which is exchangeable for equity or stock, provided certain conditions are met, in other words when issued this type of bonds looks like an ordinary bond, it pays a fixed interest rate, it has a final maturity date, but it also has a feature that permits the holder

to redeem it for shares in the borrower. Nowadays floating rate notes become quite popular as interest rates around the world are deregulated. Like its name suggest the interest rate on that bond is variable. It is usually indexed to a particular reference rate, such as the prime rate, which varies from time to time, or something called LIBOR, which is the London Inter-Bank Offered Rate, so that a holder of those notes would see the interest that they received vary

over time, depending on the levels of interest rates in the market place. If interest rates fall bellow a bond's coupon (the rate of interest paid by a fixed interest security) the bond probably sell at above par. & vice versa, if interest rates rise (this process is called price depreciation) the bond is sold at below par. By the way, the first situation with falling in interest rate is called price appreciation.

Junk bonds (or high yield securities) are the bonds that are issued by companies that are seen to have a very high risk of default, but as a result, investors are paid a premium to hold those securities because of their risk. Investors that purchase bonds are of different kinds. First of all individuals, that buy bonds for their own investment portfolios; pension funds who make investments on behalf of their members for their retirement money; they would also be mutual funds.

Investors can obtain a return on their bond investments by holding them to maturity, so receiving periodic interest payments & getting their principal back after a certain period of time. These investors are usually characterized as long-term investors or buy-&-hold investors. Or some investors prefer to trade these securities on the secondary market getting profits due changes in interest rates & therefore changes in price of bonds.

The difficulty of choosing what bonds to buy is solving by private ratings companies such as Moody's or Standard & Poors, who give an "investment grade" according to financial situation & performance of companies. Aaa is acknowledged to be the best, & C the worst, nearly bankrupt. Obviously the higher the rating, the lower the interest rate at which a company can borrow. There is no uniform system for classifying the global bond market.

Quite a number of financiers consider it appropriate to use the following classification. From the perspective of a given country, the global bond market can be classified into two markets: an internal bond market & an external one. The internal (also called national) bond market can be decomposed into two parts: the domestic & the foreign bond market. The domestic bond market is where issuers domiciled in the country issue bonds & where those bonds

are subsequently traded. The foreign bond market of a country is where bonds of issuers not in the country are issued & traded, (for instance 'Yankee bonds' in the US foreign bond market or 'Samurai bonds' foreign bonds in Japan issued by non-Japanese entities). The external bond market, also called the international bond market, includes bonds with several distinguishing features:

1. they are underwritten by an international syndicate 2. at issue they are offered simultaneously to investors in a number of countries 3. they are issued outside the jurisdiction of any single country 4. they are in unregistered form The external bond market is commonly referred to as the offshore bond market, or more popularly, the Eurobond market. The Eurobond Market is divided into different submarkets depending on the currency in which the issue is

denominated. Computerization in bond markets has reduced costs of trading bonds & made them more convenient to hold & transfer: they are not issued in certificate form - very often they are only computer entries.