Why Companies Issue Bonds

Introduction

• Companies issue bonds as a method to raise money.
• A bond is a loan between an investor and a corporation, where the investor receives periodic interest and the principal back at maturity.

Why Issue Bonds?

• Cost-effective Capital:
  • Bonds are often cheaper than equity financing.
  • No ownership or control is given up by issuing bonds as opposed to issuing stocks.
• Compared to Bank Loans:
  • Bond interest rates are typically lower than bank loan rates.
  • Bonds provide operational freedom without the restrictions often tied to bank loans, such as limits on issuing new debt or making acquisitions.

Bonds vs. Stocks

• Stock Issuance:
  • Grants ownership stakes to investors.
  • Does not need to be repaid.
  • Can dilute earnings per share (EPS) and reduce share value.
• Bond Issuance:
  • Does not affect company ownership or operations.
  • Avoids dilution of share value.

Advantages of Bonds

• Flexibility in terms of interest rates, maturities, and structure.
• Easy record-keeping; uniform terms for all bondholders.
• Companies with higher credit quality and shorter loan durations pay less interest.

Types of Bonds

• Collateralized Debt Obligations (CDOs): Backed by assets.
• Unsecured Debt: Not asset-backed; carries a higher risk and interest rate.
• Convertible Bonds: May be converted to stock shares.
• Callable Bonds: Can be redeemed early, allowing companies to refinance at lower rates if interest rates drop.

Callable Bonds

• Allow companies to lower capital costs by refinancing when interest rates decrease.
• Complex, with potential disadvantages for investors.

Comparisons

• Corporate vs. Government Bonds:
  • Corporate bonds are riskier but offer better returns than government bonds.
• Corporate Bonds vs. Stocks:
  • Bonds are generally safer, providing fixed returns, while stocks can offer higher but riskier returns.

Tax Implications

• Corporate bond interest income and capital gains are taxable.

Conclusion

• Bond market provides companies with various borrowing options.
• Investors should carefully evaluate bond investments considering risks like interest rate changes, call risks, and bankruptcy.
• Financial advisors can help navigate the bond market's complexity, or investors can choose bond funds or ETFs.