Bond Issuers Meaning
Bond Issuers are the entities that raise and borrow money, from the people who purchase the bonds (Bondholders), with the promise of paying periodic interest and repayment of the principal amount upon maturity of the bonds.
Explanation
An entity needing money can borrow the same by issuing bonds, which are purchased by bondholders. Technically, a bond issuer is a borrower, and the bondholder is the lender of the money.
Till the maturity of the bond, the bond issuer pays periodic (can be annual/ semi-annual) interest to the bondholders, and upon maturity, the issuer returns the principal amount borrowed to the holder of the bond.
Features
The following are a few of the features of Bond Issuers:
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- Entity: They can be non-individual entities only, i.e., bonds can’t be issued by an individual.
- The requirement of Money: Bond Issuer’s issue bonds when they are in requirement of funds for a variety of reasons ranging from daily operational needs to need for funding expansion for growth of the business, etc.
- Contractual Promise for Payment: They enter into a contract by way of issue of bonds whereby they are liable to pay periodic interest to bondholders and to repay the principal loan amountPrincipal Loan AmountLoan Principal Amount refers to the amount of money loaned by the lender to the borrower. Furthermore, it is the amount on which the lender charges the borrower interest for fund utilization.read more upon maturity of the bond.
- Rating: In order to issue a bond, Bond issuers are recommended, if not required, to get a credit rating from a credit rating agency. The rating tells about the creditworthiness of the issuer, i.e., its ability to pay the interest and principal. For example, the rating of a developed country like the US would be higher than any developing country like Thailand, implying that the bonds issued by the US would be relatively less risky than those issued by Thailand.
Types of Bond Issuers
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#1 – Corporations
Corporations are one of the largest categories of Bond Issuers. Both private and public corporations issue bonds to raise money for a variety of reasons. These may range from funding their day to day operations to expanding their existing businesses. Corporations include financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more, public sector undertakings, and other private companies.
For example, Microsoft, Apple, Facebook might issue bonds to finance their needs. Here these three entities are the bond issuers.
#2 – Governments
The government of a nation issues bonds in order to fund their various welfare measures or for other investment purposes. Government is generally considered relatively less risky than corporate issuers. They usually pay out interest on bonds and repay the principal from their revenue, such as taxes.
For example, the US government issues treasury bonds with borrowing money. These bonds are backed by the full support of the government.
#3 – Supranational and Multilateral Entities
These are entities that are not based in a particular nation. It includes entities like World Bank, International Monetary Fund (IMF), etc. These issuers are also highly rated and less risky because of their global standing.
World Bank issues somewhere between US$50-US$60 billion annually to support the financing of programs that support the Sustainable Development Goals.
Examples of Bond Issuers
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For example, ABC Ltd. is considering raising certain money by issuing bonds to fund its upcoming project. It issues 5-year bonds of ₹500 crores to the investors, agreeing to pay 9% interest semi-annually to the bondholders. Upon the completion of 5 years, it will repay the amount borrowed along with interest.
Here, ABC Ltd. is the Bond Issuer.
Few recent examples of Corporate Bond Issuers are:
- A US-based airplane manufacturer, Boeing, has recently issued bonds and raised money to the tune of US$25 billion in the month of April 2020.
- Indian conglomerate Reliance Industries Ltd. raised ₹8,500 crores in three-year bonds in April 2020.
Advantages
- Efficient Allocation of Capital: Bond Issuers play a vital role in capital marketsCapital MarketsA capital market is a place where buyers and sellers interact and trade financial securities such as debentures, stocks, debt instruments, bonds, and derivative instruments such as futures, options, swaps, and exchange-traded funds (ETFs). There are two kinds of markets: primary markets and secondary markets.read more by participating via issuing bonds. The excess capital with some investors can be deployed into more productive use when investors lend that money to bond issuers for their use.
- Dependency on Equity Capital: Dependency on raising money via equity shares is reduced when money can be raised by a company by acting as a bond issuer.
- Lower cost of Capital: The cost of raising capital by issuance of bonds is lower than the cost of raising capital by equity. This helps the issuer in reducing its overall cost of capital as interest on bonds is relatively lower than expected return on equityReturn On EquityReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit.read more.
Disadvantages
- Fixed Interest Obligation: Since there is a periodic interest payment which is required to be made by the bond issuers in case of bonds, this would increase the fixed cash flow burden to the issuer even when the issuer is not able to generate cash flows from its operationsCash Flows From Its OperationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital.read more due to economic downturn. Interest in bonds is mandatory to pay, whereas the dividend on equity shares is optional; hence an issuer who is in the difficult financial situations might be at a disadvantage by raising money through bonds.
- Limitations on Use: Bond Issuer might be mandated by the bond agreement to use the proceeds of the bonds in certain areas only. This would lead to limited power and control to the issuer over where the borrowed money should be used.
- Detrimental to shareholders in case of Liquidation: A corporation must pay the interest and principal when they are due, despite the financial condition of the issuer. The bondholders have a preference over shareholders upon liquidationLiquidationLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order.read more; hence the shareholders might not favor this avenue much.
Conclusion
Bond Issuers play an important role in the capital markets, helping the inefficient allocation of capital by raising money from the investors. Issuers get the desired money for carrying out their projects or daily activities, and bondholders also get a decent return on their excess capital. Issuers play that link between the excess capital with the investors and the investment project, which requires funds for their usage.
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