In this lesson, you will learn about some of the more common types of bonds and their characteristics. Bonds include: secured and unsecured bonds, term and serial bonds, registered and bearer bonds, and convertible and callable bonds.
Bonds, much like relationships, come in many varieties. Learning about the different types of bonds is a lot like searching for a mate. There are different characteristics that we want out of someone we form a relationship with. In the case of a bond, there are certain parameters that both the issuer and bondholder want to have in place to protect their interests within the bondholder/issuer relationship. This lesson will teach you about some of the more common types of bonds and their characteristics using relationships as an analogy.
Secured and Unsecured Bonds
Are you 'all in' and do you have anything to lose if you break up? How invested are you in this relationship? The first set of matchmaking criteria that we will talk about is security. We want to know how much you invest yourself in a relationship. Will the bond that you form together be one that is secured and backed by some type of tangible asset, such as a ring, house, car, etc…? Or are you the type that wants your mate to be happy with your mere expression of loyalty being enough to sustain the relationship? Let's look a bit more into the idea of security and bonds.
Secured bonds use collateral to financially safeguard the bondholder against the issuer's default. This collateral protects both the interest due on the bond as well as the principle balance. If at any time the issuer fails to pay the par value of the loan or the accrued interest, the bondholder will request for the collateral to be sold so that the profits can be put towards the bond debt.
Unsecured bonds, also called debentures, use the issuer's general credit rating to back the bond. The issuer must have a strong financial background to be in a position to issue bonds with a satisfactory interest rate that will attract investors. In other words, the bondholder is relying on the issuer's promise and good word to repay the bond. This lack of tangible assets to support the unsecured bond makes them more risky than a secured bond. However, while riskier, it also equates to a higher potential yield, since risk and yield go hand-in-hand in the financial markets.
Term and Serial Bonds
The next set of criteria to look at has to do with your level of commitment. Are you someone that is ready to commit to a date to get married, or are you the person who wants to think about it and build your relationship over time? Are you a long-term lover or a serial dater? Here is what this looks like in bond terminology.
Term bonds mature or become due on one specific date. It is a date that both the issuer and bondholder commit to whereby each party knows when the bond relationship will be terminated. The par value of the bond is paid and the bond is returned to the issuer.
Serial bonds are bonds in which a portion of the outstanding bonds matures or becomes due at several dates, which typically fall in a series. Serial bonds allow the issuer to make several staggered payments toward the par value of the bond over the life of the bond. The serial bond is often used to finance a project while providing predictable and steady income streams.
Registered Bonds and Bearer Bonds
Now, let's talk about titles. Are you the person who wants to go steady and have the title of girlfriend/boyfriend or husband/wife? Or are you just satisfied being together that you prefer not to make it Facebook official? Let's see how bonds do it!
Registered bonds are issued in the names and addresses of their holders. The bond issuer will then make payments to whoever is the registered holder. The registered bond demonstrates ownership with a title.
Bearer bonds are payable to whoever bears or holds the bond, rather than having a registered owner. This can be a risky way to go because anyone could claim ownership of the bond as long as he or she bears it. Because of the risk associated with bearer bonds, very few are in circulation today; finders keepers, losers weepers is not a fun game to play when it comes to money.
Convertible and Callable Bonds
Much like relationships, both convertible and callable bonds have an uncertain life span. People grow apart, find inexcusable differences, and go their separate ways; it is the desire by both parties to either continue or terminate the relationship. A bond that is either convertible or callable has those same provisions to discontinue the bond relationship. In the case of the convertible bond, the bondholder has the right to terminate the bond before the stated maturity date, while the issuer has that same right with callable bonds. Here is how.
Convertible bonds provide the bondholder with the right to exchange the bond for a specific number of shares in the company's common stock before the maturity date. The potential exists for the bondholder to benefit from increased stock market value of that stock; the profit potential is unlimited.
Callable bonds allow the issuer the opportunity to retire or pay off a bond at a stated dollar amount before reaching maturity. The bondholder must return the bond to the issuer, who will then pay a predetermined amount for the bond (usually the face value of the bond) together with accrued interest to date.
Let's review. Bonds come in many varieties. In this lesson, you learned about some of the more common types of bonds and their characteristics, including the following:
- Secured bonds use collateral to financially safeguard the bondholder against the issuer's default.
- Unsecured bonds, also called debentures, use the issuer's general credit rating to back the bond.
- Term bonds mature or become due on one specific date.
- Serial bonds are bonds in which a portion of the outstanding bonds matures or becomes due at several dates, which typically fall in a series.
- Registered bonds are issued in the names and addresses of their holders.
- Bearer bonds are payable to whoever bears or holds the bond, rather than having a registered owner.
- Convertible bonds provide the bondholder with the right to exchange the bond for a specific number of shares in the company's common stock before the maturity date.
- Callable bonds allow the issuer the opportunity to retire a bond at a stated dollar amount before reaching maturity.
By the end of this lesson you should be able to recall, discuss, and compare different types of bonds available.