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27 Feb 2019

What is a bond and what different types of bonds are there?

When we sell a bond in the aftermarket what are some of the things we must consider?

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Bunny Greenfelder
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27 Feb 2019

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There are various types of bonds that can be issued, to include:term bonds, serial bonds, callable bonds, secured and unsecuredbonds, convertible bonds, commodity-backed bonds, deep discountbonds, registered and coupon bonds, and income and revenue bonds.Please discuss the differences of each bond, how they function andwhy businesses may choose one over another.

Consider this question:

Assume that your bond has an interest rate of 10 percent when other bonds are paying 12 percent. Investors will not want to buy your bond if they can earn 12 percent elsewhere. What can you do to get investors to buy your 10 percent bond? (Answer: lower the price)

You will need to drop the price of your bond so investors are really getting a 12 percent return. In other words, you need to drop the price to the present value of the bond using a 12 percent interest rate. You will need to sell the bond at a discount.

The selling price of a bond is determined by the relationship between the bond’s contract interest rate and the market interest rate when the bond is sold.

If contract rate = market rate, bond sells at face value.

If contract rate > market rate, bond sells at a premium.

If contract rate < market rate, bond sells at a discount.

DEMONSTRATION PROBLEM 3 — Issuance of a Bond (Premium)

On January 1, a corporation issued a $1 million, five-year, 11 percent bond that pays interest semiannually. The market interest rate on January 1 was 10 percent. What would be the journal entry to record the issuance of this bond? (The market value of the bond, so you won’t have to calculate it yourself, is $1,038,606).

The credit rating for the United States was recently downgradedfrom AAA to AA+ for the first time in history. We learn that BondRating Criteria is very similar to the process that you are usingfor your Projects -- financial ratios and qualitative factors. Howimportant are bond ratings to the general public? Remember whilesome bonds find their way into mutual fund portfolios most bondsare traded by financial institutions and governments. As you'reformulating your answer consider if you would be willing to accepta bond with a lower rating that has the possibility of paying ahigher return.

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