Why Companies Issue Bonds

Introduction

• Companies issue bonds to raise money, functioning as a loan between an investor and a corporation.
• Investors provide a certain amount of money for a specific period, receiving periodic interest payments; the company repays the principal upon maturity.

Key Takeaways

• Companies can raise capital by issuing stocks or bonds.
• Bond financing is usually less costly than equity and doesn't require giving up control over the company.
• Debt financing can be through bank loans or bond issuance.
• Bonds often offer advantages over bank loans, including lower interest rates and greater operational freedom.

Bonds vs. Banks

• Companies often choose bonds over bank loans as they typically offer lower interest rates.
• Bonds provide companies with operational freedom, avoiding restrictive covenants of bank loans.
• Issuing bonds allows corporations to invest in growth opportunities at low-interest rates.

Bonds vs. Stocks

• Issuing stock dilutes ownership and earnings, affecting earnings per share negatively.
• Bonds avoid dilution, maintaining ownership structure.
• Companies can continue issuing bonds provided investors are willing, without affecting company operations.

More About Bonds

• Bonds facilitate efficient large-scale lending with uniform interest rates and maturity dates.
• Bond types offer flexibility in terms of credit quality and duration, affecting interest rates.

Types of Bonds

1. Collateralized Debt Obligations (CDOs): Backed by assets, allowing investors to claim assets if default occurs.
2. Unsecured Debt: Not backed by assets, involves higher risk and therefore higher interest.
3. Convertible Bonds: Can be converted into stock shares, allowing potential gains from stock price increases.
4. Callable Bonds: Allow issuer to repay before maturity, benefiting from dropping interest rates.

Advantages of Callable Bonds

• Callable bonds enable companies to refinance if interest rates drop, reducing capital costs.
• They involve complexities and may not suit risk-averse investors.

Corporate vs. Government Bonds

• Corporate bonds are issued by corporations, generally riskier than government bonds.
• Government bonds fund governmental needs, considered safer, offering lower returns.

Safety of Corporate Bonds vs. Stocks

• Corporate bonds offer fixed returns, considered safer than stocks, which are riskier but potentially more rewarding.

Tax Implications

• Corporate bonds are not tax-free; taxes apply to interest income and capital gains.

Conclusion

• The bond market offers diverse borrowing options for companies and investment opportunities for investors.
• Due diligence is crucial for investors to understand returns, risks, and timelines.
• Financial advisors can guide bond market investments, considering risks like interest rate changes and corporate bankruptcy.
• Alternatives like bond funds or ETFs provide simplified investment options.