Bonds: what are the pros and cons

Issuing bonds allows companies to attract a large number of lenders in an efficient manner. Accounting is simple because all bondholders get the same deal. For any given bond, they all have the same interest rate and maturity date. Corporations also benefit from the flexibility to offer a wide variety of bonds. A quick look at some of the variations illustrates this flexibility.

The duration and credit quality of bonds are the two key factors that influence the interest rate on a bond. For instance, if a company needs short-term funding, it can issue bonds that mature within a short period. On the other hand, if it has sufficient credit quality, it can extend its loans up to 30 years.

The credit quality of bonds is influenced by a company’s long-term loan and its fiscal health. A company’s shorter duration and better health can lead to lower interest payments. Conversely, issuers of long-term debt who are not fiscally healthy are forced to pay higher rates in order to attract investors.

Different Types of Bonds 

Offering asset-backed bonds is one of the more interesting options available to companies. These bonds give investors the right to claim the underlying assets of a company in the event of the company’s default. These types of bonds are known as collateralized debt obligations (CDOs). In consumer finance, auto loans and home mortgages are examples of collateralized debt.

In addition, companies may issue debt instruments that are not backed by any underlying assets. In consumer finance, examples of loans that are not backed by collateral include credit card debt and utility bills. Such loans are called unsecured debt. Unsecured debt often carries a higher interest rate than secured debt because it carries more risk for investors.

Another type of bond is the convertible bond. These bonds start out the same as other bonds, but they offer investors the opportunity to convert their holdings into a pre-determined number of shares of stock. In a best-case scenario, such conversions allow investors to take advantage of rising stock prices and provide companies with a loan that they don’t have to repay.

Last but not least are callable bonds. They are like other bonds, but the issuer has the option to redeem them before the official maturity date.

Corporate bonds are safer than stocks. Corporate bonds offer a fixed rate of return, so an investor knows exactly how much he or she will get back. Stocks, on the other hand, usually offer a better return because they are riskier. So, while money invested in a corporate bond may earn 3%, it may also miss out on earning more if the stock rises more than 3%; however, the stock may also not rise more than 3%. The right investment depends on the investor’s risk tolerance and investment objectives.