What is a bond? Definition
A bond is a contract that precisely stipulates that, as part of a bond issue, several subscribers (investors) provide the issuer with a specific amount of capital for an agreed-upon term and interest rate. Thus, the subscriber is a creditor of the issuer and is entitled to interest as well as repayment of the principal. This creates a relationship between a creditor and a debtor. The subscriber has the option of either holding the bond until repayment (redemption) or reselling it beforehand.
The sale of securities at the time of issuance is referred to as the primary market, while trading on stock exchange markets or over-the-counter trading is referred to as the secondary market.
Importance of bonds
Bonds offer interest rates which are agreed upon in advance and they are generally higher than those on a savings account. The interest rate may be fixed for the entire term or may vary (floating-rate debt securities = floaters). Bonds can be sold at any time, though there is a certain price risk involved. A crucial factor for investors is the issuer’s creditworthiness, which is its ability to meet all financial obligations over the life of the bond.
Types of bonds
Bonds can be classified according to the following criteria:
- Interest structure and maturity: fixed-rate (“straight bonds”) and floating-rate bonds (“floaters”), zero-coupon bonds (payable at maturity)
- Secured rights: convertible bonds, bonds with warrants, profit-sharing bonds
- Issue currency and place of issuance: dual-currency bonds, mixed-currency bonds, domestic bonds, foreign bonds
- Type of collateral: bonds backed by a cover pool or public guarantees (secured/government-backed securities), unsecured bonds, subordinated bonds
Classification by issuer
The most actively traded bonds are so-called government bonds. These may include federal bonds of the Republic of Austria, state bonds, and municipal bonds. Banking bonds are issued by credit institutions. The credit institutions, in turn, make the raised capital available to borrowers. Corporate bonds are becoming increasingly popular among companies as an alternative financing option. A particular advantage for companies is that existing credit lines are not drawn upon, the capital raised does not need to be repaid until the end of the term, and, at the same time, no ownership shares need to be issued.
