Bond vs Loan

Difference Between Bond and Loan

The primary difference between Bonds and Loan is that bonds are the debt instruments issued by the company for raising the funds which are highly tradable in the market i.e., a person holding the bond can sell it in the market without waiting for its maturity, whereas, loan is an agreement between the two parties where one person borrows the money from another person which are not tradable generally in the market.

The terms bond and loan are related to each other; however, they are not the same and have specific core differences. Both are debts. A bond is a kind of loanBond Is A Kind Of LoanA bond is financial instrument that denotes the debt owed by the issuer to the bondholder. Issuer is liable to pay the coupon (an interest) on the same. These are also negotiable and the interest can be paid monthly, quarterly, half-yearly or even annually whichever is agreed mutually.read more that will be used by large entities or the corporations or the governments to raise capital, which they require for operating their business, and it’s done by selling IOUs to the public.

What is Loan?

A loan is a debt in which a lender will lend the money, and a borrower will borrow the money. A specific time limit will be set for the repayment of the debt-money, which includes both the interest amount and the principal amount which has been borrowed by the borrower from that lender. This principle amount is mostly paid in installments regularly. When every installment is a similar amount of money, it will be called an annuity.

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What is Bond?

Bond is commonly referred to as the fixed-income securities and is one of 3 major asset classes that individual investors are usually most familiar with, along with stocks (i.e., equities) and cash equivalentsCash EquivalentsCash equivalents are highly liquid investments with a maturity period of three months or less that are available with no restrictions to be used for immediate need or use. These are short-term investments that are easy to sell in the public market..read more. Many government and corporate bondsCorporate BondsCorporate Bonds are fixed-income securities issued by companies that promise periodic fixed payments. These fixed payments are broken down into two parts: the coupon and the notional or face value.read more are publicly traded; others are traded only over-the-counter (i.e., OTC) or privately between the lender and the borrower.

Bond vs. Loan Infographics

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Critical Differences Between Bond and Loan

  • The main difference is that a bond is highly tradeable. If you purchase a bond, there is usually a market place where you can trade it. It means you can even sell the bond, rather than waiting for the end of the thirty years. In practice, people purchase bonds when they wish to increase their portfolio in that way. Loans tend to be the agreements between borrowers and the banks. Loans are generally non-tradeable, and the bank will be obliged to see out the entire term of the loan.
  • In the case of repayments, bonds tend to be only repaid in full at the maturity of the bond – e.g., 10, 20, or 30 years. Banks perhaps expect the repayment of both principal and interest during the repayment period at regular intervals.
  • Interest rates on government bonds are generally lower. The US and the UK Government bonds are perhaps treated as low-risk. Private loans on unsecured debt, on the other hand, are likely to attract a higher rate of interest. Corporate bonds are mostly somewhere in between – depending upon the reputation of the corporate.
  • Issuing bonds give the corporates significantly greater freedom to operate as they deem fit because it frees them from the restrictions that are often attached to the loans that are lent by the banks. Consider, for example, that lenders or the creditors often require corporates to agree to a variety of limitations, such as not to issue more debt or not to make corporate acquisitions until their loans are repaid entirely.
  • The rate of interest that the companies pay the bond investors is often less than the rate of interest that they would be required to pay to obtain the loan from the bank.
  • Bonds that are traded in the market do possess credit rating, which is issued by the credit rating agencies, which starts from investment grade to speculative grade, where investment-grade bonds are considered to be of low risk and usually have low yields. In contrast, speculative bonds are considered of higher risk, and hence they are traded at higher yields to compensate the investors for the risk premiumThe Risk PremiumRisk Premium, also known as Default Risk Premium, is the expected rate of return that the investors receive for their high-risk investment. You can calculate it by deducting the Risk-Free Investment Return from the Actual Investment Return. read more. On the contrary, Loan doesn’t have any such concept; instead, the creditworthiness is checked by the creditor.

Comparative Table

Basis – Bond vs. Loan BondLoan
DefinitionIt is a kind of debt instrumentDebt InstrumentDebt instruments provide finance for the company's growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans.read more. It is a way for the government or a company to raise money by selling, in effect, IOUs – with interest payments annually.A loan is also another kind of a debt instrument, provided by a bank mostly private with a variable rate of interest.
Interest RatesGovernment bond yieldsBond YieldsThe bond yield formula evaluates the returns from investment in a given bond. It is calculated as the percentage of the annual coupon payment to the bond price. The annual coupon payment is depicted by multiplying the bond's face value with the coupon rate.read more are likely to be low and are a safer investment.Comparatively to Bond, the loan interest rates in most of the cases are higher, and in case it’s an unsecured loan, then its interest rate would be much higher.
Source placeBonds can be sold on bond markets to financial/public institutions.Loans are sanctioned by the banks mostly.
OwnershipGovernments or firms usually sell bonds.Corporates or individuals borrow them.
Type of interest rateInterest rates on bonds either could be fixed, variable, or there could be no interest either like in case of zero-coupon bondsZero-coupon BondsIn contrast to a typical coupon-bearing bond, a zero-coupon bond (also known as a Pure Discount Bond or Accrual Bond) is a bond that is issued at a discount to its par value and does not pay periodic interest. In other words, the annual implied interest payment is included into the face value of the bond, which is paid at maturity. As a result, this bond has only one return: the payment of the nominal value at maturity.read more, which are issued at a discount to the par. The difference is the taken as interest and are booked pro-rata basis.Interest rates on loans are either fixed rates or variable rates that are linked with the base rate.
TradingBonds that are sold and purchased at the bond markets and bond pricesBond PricesThe bond pricing formula calculates the present value of the probable future cash flows, which include coupon payments and the par value, which is the redemption amount at maturity. The yield to maturity (YTM) refers to the rate of interest used to discount future cash flows.read more can move up and down like the stock prices.Loans are generally fixed with the bank that has to lend it.
Examples10-year US treasury bonds, Mortgage-backed security (MBS), Asset-Backed securityAsset-Backed SecurityAsset-backed Securities (ABS) is an umbrella term used to refer to a kind of security that derives its value from a pool of assets, such as bonds, home loans, car loans, or even credit card payments.read more (ABS), etc.;Term loans, variable bank loans, cash credit, etc.

Conclusion

Loans are a kind of debt in which a lender will lend the money, and a borrower will borrow the money. A specific time is set for the repayment of the debt-money, which includes the interest and the principal amount which has been borrowed by the corporate or any individual borrower from the lender; a bond, on the other hand, is a type of loan also known as debt security. In the case of bonds, the public is the creditor or the lender, and big corporations or the government are usually the borrowers.

Loans are not usually tradeable, as mentioned earlier, whereas bonds do have a market where they can be traded before the bonds are matured.

Bond vs. Loan Video

 

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