Bond Definition and Characteristics

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Understanding bonds begins with its definition and purpose. A bond is a certificate issued by an institution containing an absolute promise to pay a certain amount of money with interest at a specific future date. Understanding bonds requires that the purpose should be carefully identified by the issuing company.

Normally, bonds are issued to obtain long term financing not from the traditional lending institution but from another company or individual. Understanding bonds includes an awareness that for bonds to be legal should have the approval of the company stockholders before issuance is allowed. Understanding bonds covers that the binding agreement between the issuing company and the investors is called a deed of trust or bond indenture.

Understanding bonds involves knowing how the bonds are sold. To have a better understanding of bonds, the issuing company must have ample knowledge since sale of bonds faces plenty of preliminary work.

The sale of bonds is a means for the company to raise funds. Understanding bonds requires that funds usually needed are too big for a single buyer to pay. Hence, understanding of bonds entails that it should be divided into different denominations such as $100, $1,000, $10,000, etc. This is to allow more than one investor or buyer to acquire the issuance of bonds.

However, for purposes of simplicity, bonds are sold by the issuing company in equal denominations, for example, at $1,000 each. Understanding bonds means that the $1,000 denomination is called face value of bonds. Each bond issuance is supported by a certificate of indebtedness commonly called bond certificate.

Hence, if the issuing company sold $500,000 value of bonds with $1,000 denominations, 500 bond certificates will be issued containing a face value of $1,000.

The sale of bonds can be handled by issuing company or by an underwriter. Normally, the entire issuance of bonds is sold to an underwriter. The underwriter assumes full responsibility in selling the bonds to different interested investors. In some cases, the underwriter undertakes the selling of bonds on a commission basis. The commission is deducted from the proceeds of sale when remitting the sales proceeds to the issuing company.

Issuance of bonds is preferred by some companies over shares of stock. If a certain stock is issued, say common stock, the controlling interest of the present common stockholders will be minimized unless subscription is made for the new stock issue. Hence, instead of issuing new stocks to raise funds, bonds are issued.

In the issuance of non-voting preferred stock, the control of existing common stockholders will not be affected. However, preferred stock dividends must be paid before any common stockholders will receive dividends.