Related topics bonds - mot

 

What is a bond?

Basic bond concepts

A bond is a credit instrument representing a portion of a debt raised by a company or public body to finance itself.  It guarantees the buyer repayment of capital plus an interest rate.

Bonds are issued in order to procure, directly from investors and on more advantageous terms with respect to those of bank loans, funds for investment purposes.  The advantage for the issuer concerns the interest rates which are normally lower than those it would be required to pay for a bank loan with similar maturity, while the investor benefits by a higher interest rate with respect to that of a cash investment and has the possibility to convert his investment in the secondary market.

The holder of a company’s debt securities, while assuming the business risk, unlike a shareholder, does not participate in the issuer’s management activity, since he has no voting rights at the shareholders’ meetings.  On the other hand, however, the remuneration of equity risk capital is subordinated to the prior payment of interest and repayment of principal to bondholders.

However, there are some bonds (convertible bonds) which may be converted to shares of the issuer, or of a company belonging to the same group.  Following conversion the investor ceases to be a bondholder and becomes a shareholder, therefore acquiring all relative rights.

The coupon is the interest paid during the life of the security: it can have a quarterly, semiannual or annual periodicity. Interest may be fixed (established beforehand) or variable (usually indexed to Libor or Euribor plus a spread or to other official rates and normally adjusted on a six-monthly basis). Often, to encourage subscription, the bonds are issued below par, i.e. the nominal value (or the value to be redeemed at maturity) is higher with respect to the subscription price (which is what you pay to purchase the bond): in this way the yield increases.

The so-called “zero coupon” securities, on the other hand, do not pay interest in the form of coupons during their life and the yield is calculated solely on the difference between the nominal value and the subscription price.  Much more rarely the bonds are priced at par (issue price and nominal value are the same) or above par (nominal value lower than the issue price). To protect subscribers against the risk of insolvency of the issuer, the law states that the bonds cannot be issued for an amount greater than the issuer’s paid up and existing share capital according to the last approved balance sheet; it is generally possible to depart from this principle only if the issue is supported by guarantees.