In finance and economics, a bond or debenture is a debt instrument that obligates the issuer to pay to the bondholder the principal (the original amount of the loan) plus interest.
Thus, a bond is essentially an I.O.U. (I owe you contract) issued by a private or governmental corporation.
The corporation “borrows” the face amount of the bond from its buyer, pays interest on that debt while it is outstanding, and then “redeems” the bond by paying back the debt.
A mortgage is a bond secured by real estate.
- A written and signed promise, to pay a certain sum of money on a certain date, or on fulfilment of a specified condition. All documented contracts and loan agreements are bonds.
- Construction: A three-party contract (variously called bid bond, performance bond, or surety bond) in which one party (the surety, usually a bank or insurance company) gives a guaranty to a contractor’s customer (obligee) that the contractor (obligor) will fulfil all the conditions of the contract entered into with the obligee. If the obligor fails to perform according to the terms of the contract, the surety pays a sum (agreed upon in the contract and called liquidated damages) to the customer as compensation.
A surety bond is not an insurance policy and, if cashed by the obligee, its amount is recovered by the surety from the obligor.
- Law: (1) An appeal bond deposited by a losing party to stay the execution of a lower court’s judgment until the party’s appeal against it is decided by a higher court. (2) A bail bond deposited by an accused as a guaranty of his or her appearance in the court when called. (3) A judicial bond deposited by a litigant to indemnify the opposing judicial or governmental body from any loss arising due to the legal proceeding.
- Securities: A debt instrument that certifies a contract between the borrower (bond issuer) and the lender (bondholder) as spelt out in the bond indenture. The issuer (company, government, municipality) pledges to pay the loan principal (par value of the bond) to the bondholder on a fixed date (maturity date) as well as a fixed rate of interest for the life of the bond.
Alternatively, some bonds are sold at a price lower than their par value in lieu of the periodic interest.
On maturity, the full par value is paid to the bondholder. Bonds are issued in multiples of $1,000, usually for periods of five to twenty years, but some government bonds are issued for only 90 days. Most bonds are negotiable and are freely traded over stock exchanges. Their market price depends mainly on the rating awarded by bond rating agencies on the basis of issuer’s reputation and financial strength. Investment in bonds offers two advantages: (1) known amount of interest income and, unlike other securities, (2) considerable pressure on the company to pay because the penalties for default are drastic. The major disadvantage is that the amount of income is fixed and maybe eroded by inflation. Companies use bonds to finance acquisitions or capital investments. Governments use bonds to keep their election promises, fund long-term capital projects, or to raise money for special situations, such as natural calamities or war.
- Commerce: A bank guaranty posted by an importer for an immediate release of landed goods (with a total value not exceeding the amount of bank guaranty) without payment of customs duties and taxes. The bond allows a fixed period during which the importer must submit the required documents and pay the assessed duties and taxes. See also bonded goods.