Bonds: definition and types

Bonds refer to both secured and unsecured debt. Both are papers acknowledging debt.

They are long term debt instruments that promise to pay interest periodically.


Types of Bonds

(a)       Floating rates bonds

The coupon rate or contractual rate of interest on these bonds is not fixed but facilitate from time to time so as to reflect the current market rate of interest.

When the market interest rates go up, the coupon rate adjusts upwards. The lender benefits because he is able to participate in higher interest rates when the market interest rates fall, the coupon rate adjusts downwards. The borrower benefits because costs of funds go down due to the matching of the coupon rate to the market rate of interest, market price of the debentures become much more stable.


(b)   Zero Coupon Bond

No interest is payable on this bonds before maturity of disposal. Interest is effectively accrued and accounted for in the redemption raise of the bonds or reflected in its current market value.

The lender is not locked into a low fixed rate of interest but is able to participate in higher rates.

Cost of funds to the borrower reflects the interest rates prevailing.

No cash outflows are experienced by the borrower before maturity.


(c)    Convertible Bonds

These are bonds that may be converted into another form of security, usually ordinary shares at the option of the holder at a specified price within a specified period of time.

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