The question is, why might a town decide to issue bonds?
The answer to the question can be given in three or four lines. But in order to understand the answer, it is really crucial first to understand what a bond is.
Once we get the proper idea about the definition of bonds, it will be much easier to figure out the answer to our primary question. But, of course, you may also be able to find out the answer by knowing. But do not worry, I will answer your question – Why might a town decide to issue bonds?
What Is A Bond?
A bond is a secured debt that is issued by either the government or any corporate body. It is owed to the holders by the issues. The two most popular types of bonds are:
- Munis or Municipal bonds issued by the government
- Corporate bonds – issued by any business or corporate body. A bond can be in mutual funds or private investing. Here a person gives a loan to the government or a company.
The bond is nothing but a secured debt, as I have told you earlier. Under this, the issuer owes a debt to the holders, and the issuer is obliged to pay the interest based on the bond terms.
Or the issues also can pay back the capital along with the interests on a certain date. This date is termed the maturity date. These interests are payable at fixed intervals, which can be annual, semiannual, or sometimes monthly.
If you are wondering why might a town decide to issue bonds, first, you need to understand that a bond can be negotiable. When I am saying bond is negotiable, it means the instrument’s ownership can also be transferred in the secondary market.
So, once at the bank, the transfer agent medallion stamps the bond; it is highly liquid on the market on the market.
The Features Of Bonds
Now, as you get an idea about what a bond is, let’s dig a little deeper and know the features of a bond.
Principal, Nominal, par, or face amount is the particular amount on which the issuer needs to pay the interest, and most commonly, this amount also needs to be paid back at the end of the term.
There are also some structured bonds, which may also have a different redemption amount from the face amount. And this can be linked to the particular asset’s performance.
On the maturity date, the issuer is obliged to pay back the nominal amount. However, if all the due payments are made after the maturity date, the issuer further has no obligations to the bondholder.
The time length until the maturity date is mostly referred to as any bond’s tenor, term, or maturity. And maturity can be of any length. However, most bonds have a term that is shorter than 30 years.
The United States Treasury securities market has four categories of bond maturities. And they are:
- Short Term or Bills: The maturity lies between zero to one year.
- Medium Term or Notes: The maturity lies between one to ten years.
- Long Term or Bonds: The maturity lies between ten to thirty years.
- Perpetual: It has simply no maturity period.
The interest rate that the issuer needs to pay the holder is termed a coupon. When it is a fixed rate bond, the coupon remains fixed throughout the whole life of the particular bond. But the scenario is totally opposite for floating-rate notes. Therefore, based on the money market reference rate movement, the coupon varies throughout the entire life of the particular bond.
Historically, to paper bond certificates, coupons are physically attached. And each coupon represents an interest payment. So the bondholder needs to hand in the same coupon to the bank in return for the interest payment on the very interest due date.
But in recent days, interest payments are mostly made electronically. And the interest also can be paid at different frequencies, generally semiannual, i.e., 6 months or annual.
The rate of return that is received from investing in the bond is referred to as yield. By saying yield, I am referring to two different aspects. They are:
- The current or running yield. Divide the annual interest payment by the bond’s current market price, and you will get the running or current yield. It is also often called clean price.
- The redemption yield or yields to maturity. Consider an investor who buys any bond at the given market price rate, on schedule, receives all interest along with the principal, and also holds the bond to maturity. Now the internal rate of return that the investor earned is called redemption yield.
Types Of Bonds
Before knowing why might a town decide to issue bonds, let’s have a look at the different types of bonds.
1. Fixed-Rate Bonds
A fixed-rate bond offers the same level of interest over its entire term. So if you are looking for some guaranteed returns after a certain tenure, Fixed Rate Bonds might be just your cup of tea.
2. Floating Rate Notes
A Floating rate note is a debt instrument with a variable interest rate. In addition, this interest rate is tied to the benchmark rate. These are issued by financial institutions and have a maturity period of 2-5 years.
3. Zero-Coupon Bonds
A Zero-coupon bond is a debt security that doesn’t offer interest but trades at a deep discount. The profits are made with this bond by redeeming it with a face value in the future.
4. High-Yield Bonds
High-yield bonds offer higher interest rates because they have lower credit ratings than most investment-grade bonds.
5. Exchangeable Bonds
An Exchangeable bond is a hybrid debt security that can be converted into the shares of the company. Companies issue this bond for several reasons, but the tax savings and divesting a large stake are the most influential.
6. Convertible Bonds
A Convertible bond is a fixed income debt security that yields interest payments. The conversion of the bonds to stocks can be done at a certain time during the bond’s life.
7. Inflation-Indexed Bonds
An Inflation-indexed fund is a security fund that guarantees a higher return than the rate of inflation.
8. Equity-Linked Notes
An Equity-linked note is an investment product that ensures you get some fixed interest from your investment and some additional profits based on how the equity performs. Hence, with the Equity-linked notes, you get to sources of income with a single investment.
9. Asset-Backed Securities
An asset-backed security is an investment that is collateralized by the underlying pool of assets. These assets take the form of bond or note and offer an interest income till it reaches its maturity.
10. Covered Bonds
A covered bond is a package of loans issued by the banks and sent to financial institutions for resale. On the contrary, it is a type of derivatives instrument that mostly includes public loans and mortgages.
These are the bonds that are mostly used in the market. However, there are other bonds as well that might interest you.
- Subordinated bonds
- Perpetual bonds:
- Bearer bonds.
- Registered bonds.
- Government bonds.
- Supranational bonds.
- Municipal bonds.
- Book-entry bonds.
- Lottery bonds.
- Serial bonds.
- War bonds.
- Revenue bonds.
- Dual currency bonds.
- Climate bonds.
- Retail bonds.
- Social impact bonds.
Why Might A Town Decide To Issue Bonds?
From the above discussion, after you get some knowledge about the bond, its features, and different types of bonds, you may have got the answer to your question -why might a town decide to issue bonds? The bottom line is that a bond will allow you to get the capital money along with some interest rate after maturity. This is a way the issuer, government, or corporation gets rid of their debt.
So, next time you invest your money in bonds, make sure you have done your homework or research properly. You can choose any of the different types of bonds.
As I have given you a wide range of options to choose from, plenty of research, and all the basic knowledge on why might a town decide to issue bonds, it will be enough not to lose your money and make the right investment decision.