What Are Bonds Payable?
Bonds payable, or long-term bonds, is a source of financing that is available to large corporations. Bonds denote a responsibility to repay a principal amount at some pre-determined future date as well as a requirement to pay interest on that principal periodically throughout the year. Interest payments on bonds may be due quarterly, semi-annually or annually, depending on the bonds payable agreement. Bonds are typically issued in large numbers at once to a variety of lenders or investors. The investors have the option to sell their bonds to another investor prior to the bonds' maturity.
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Types
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There are many different types of bonds payable, but the most common types issued today are registered bonds. This means that the bonds are issued in the name of a particular owner. Other types of bonds payable are bearer bonds, which require the holder to present the bonds at the bank for interest or principle payment; secured bonds, which require collateral from the borrowing company to be pledged to the bondholder; serial bonds, which are issued in groups and mature at different dates; and debenture bonds, which rely only on the good name and financial stability of the company that issues the bonds, rather than any type of collateral.
Pricing
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Bonds payable prices are based on the rate of risk associated with the company that sells the bonds. The market assesses the risks, and the higher the risk, the higher the interest rate paid for the bond. Bonds are offered at a premium when their interest rates are higher than the market's assessed rate of interest for than company. Bonds are issued in thousands. If a bond has a market price of $100, then it is sold for 100 percent of its face value. If a bond has a market price of $105, it is a premium and the bearer will receive $1,050 for the bond. If it sold for $95, it sold at a loss and the issuing company will receive $950.
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Function
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If your company needs to raise money, it can issue $100,000 of 10-year bonds with a coupon interest rate of 5 percent and semi-annual interest payments. This means that the entities buying the bonds will give your company $100,000, which is payable back to them in 10 years on the maturity date. You company will also pay interest in the amount of $2,500 ($100,000 multiplied by 5 percent coupon interest rate, multiplied by 6/12) every 6 months.
Benefits
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The benefit of issuing bonds payable to a company is to gain immediate cash flow that may not be accessible through other banking channels. For the investors, the benefits are balanced against the risks of the company issuing the bonds. For instance, in the previous example where your company issued $100,000 of bonds, the total amount paid to the investors over the life of the bonds is $150,000. They received $100,000 at maturity and $2,500 twice a year for 10 years.
Considerations
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Always know which type of bond you are investing in before you spend any money. Research the issuing company's financial information to determine the viability of getting your money returned to you. If you do choose to invest in bonds payable, the interest you receive may exceed what you would earn in other types of financial instruments.
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Resources
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