Bond

What it means

A bond is a security through which the issuer borrows money from investors. It undertakes to pay a return on agreed dates and to repay the nominal value on the maturity date.

Unlike a share, it grants no ownership stake and no vote at the general meeting. The holder is a creditor: in insolvency they rank ahead of the shareholders but behind secured creditors.

Not every bond pays a regular coupon. With a discount bond the investor buys below nominal value, and the return is the difference between the purchase price and the amount paid out at maturity. Economically it is the same interest, only paid in one sum at the end rather than along the way.

How it works in practice

For a smaller company an issue is an alternative to a bank loan: the money comes from several investors, but it brings a prospectus or the conditions for an exemption from one, a register of holders and regular coupon payments.

On the investor side a purchased bond is a financial asset, classified by whether the company holds it to maturity. On the issuer side it is a liability, and the coupon accrues into expenses over time, not on the payment date.

When a bond is bought on the secondary market, the buyer also pays the interest accrued since the last coupon. On the investor side we book it separately from the bond’s price, and at year end we use accruals to record income that has already built up even though the coupon has not yet been paid.

What to watch out for

Before paying a return to an individual or abroad, settle who withholds the tax and at what rate. An issuer that failed to remit it pays out of its own pocket, even though the investor already received the full amount.

Bonds of smaller companies sold directly to investors often have no liquid market, and a high coupon is usually the price of risk. Read the issuer’s financial statements before buying: once it stops paying, the investing company stands among unsecured creditors, and money comes back rarely and slowly.