bond

bond, in finance, a loan contract issued by local, state, or national governments and by private corporations specifying an obligation to return borrowed funds. The borrower promises to pay interest on the debt when due (usually semiannually) at a stipulated percentage of the face value and to redeem the face value of the bond at maturity in legal tender. Bonds usually indicate a debt of substantial size and are issued in more formal fashion than promissory notes, ordinarily under seal. Contract terms are normally found in the indenture, an agreement between the borrower and a trustee acting on behalf of the bondholders. Interest payments on bonds are known as coupon payments; before electronic interest payments made the coupon system obsolete, the bond purchaser received a series of numbered coupons with the bond that represented every interest-payment date throughout the life of the bond. These were clipped from the bond by the bondholder and presented for payment, which usually occurred semiannually.

When bonds are sold, interest accrued since the previous interest-due date is added to the sale price. Most bonds are payable to the bearer and are thus easily negotiable, but it is usually possible to have the bond registered and thus made payable only to the named holder. The great majority of bonds are callable, meaning that the issuer can redeem them at his option, upon appropriate notice, well before maturity. Maturity dates for bonds normally run from 5 to 30 years.

Government bonds may be backed by the taxing power of the government unit issuing the bond, or they may be revenue bonds, backed only by the revenue from the specific projects—e.g., toll roads, airports, waterworks—to which they are committed. Corporate bonds may be secured by a lien against real estate (mortgage bonds) or other property, such as equipment (equipment obligations) owned by the borrower. If the bond is unsecured, it is known as a debenture bond.

Bond ratings are grades given to bonds on the basis of the creditworthiness of the government, municipality, or corporation issuing them. The ratings are assigned by independent rating agencies (in the United States the largest are Standard & Poor’s and Moody’s Investors Service), and they generally run from AAA to D. Bonds with ratings from AAA to BBB are regarded as “investment grade”—i.e., suitable for purchase by banks and other fiduciary institutions. Bonds with ratings below BBB are considered “junk,” or high-yield, bonds; they are often issued by new or speculative companies. Although the risk of default for junk bonds is great, they offer higher rates of interest than more secure bonds.