A bondholder is an investor who buys or holds a government or corporate bond. Bondholders are basically creditors lending capital to the issuing entity (borrower) in exchange for periodic interest earnings and redemption on maturity. Besides, they can also benefit by trading the bonds on secondary markets.
A bond is a relatively safe investment due to the fixed nature of its returns. However, a bondholder must consider inflation, interest rate, and default risksDefault RisksDefault risk is a form of risk that measures the likelihood of not fulfilling obligations, such as principal or interest repayment, and is determined mathematically based on prior commitments, financial conditions, market conditions, liquidity position, and current obligations, among other factors. to weigh the real gain from it. Unlike shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares., they are not owners. However, they have a prior claim over a company’s assets in the event of 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.. An investor may purchase bonds Bonds Bonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.either directly from the issuing body or on the secondary market via an agent.
Table of contents
- A bondholder is an investor who bears a bond issued by the government or corporation.
- Two main forms of bonds are government and corporate bonds.
- Bondholders lend funds to the issuer and receive the amount back when the bond matures, along with fixed interest earnings over the bond’s life.
- They can either keep collecting the interest amount or sell the bonds at a higher rate for immediate profit.
- Bondholders (creditors) differ from shareholders (owners) in status, earnings, voting rights, and repayment priority.
A bondholder denotes a moneylender offering funds to the bond-issuing entity. Bonds are debt instrumentsDebt InstrumentsDebt 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. issued by the government or corporation to obtain capital to finance their projects. They come with a fixed interest or coupon rate remitted periodically to the holder and assurance of repayment of original bond value at maturity.
Bonds are negotiable instrumentsNegotiable InstrumentsA negotiable instrument refers to the transferrable and signed written document whereby the payer guarantees or promises to pay a certain sum on a specific future date or as on-demand to the payee or bearer. It includes bills of exchange, delivery order, promissory note, customer receipt, etc. and hence can be traded in secondary marketsSecondary MarketsA secondary market is a platform where investors can easily buy or sell securities once issued by the original issuer, be it a bank, corporation, or government entity. Also referred to as an aftermarket, it allows investors to trade securities freely without interference from those who issue them.. Bondholders can choose to hold the bond accumulating the interest earnings over time and redeeming it at the end of its tenure. Or else, they can sell the bonds at a relatively higher price in the bond market, cashing in the profits. However, they lose the right to gain interest earnings after selling the bonds.
Types of Bonds
Two main forms of bonds are government or municipal 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.. National or local government issues government or municipal bondsMunicipal BondsA municipal bond is a debt security issued by a national, state, or local authority to finance capital expenditures on public projects related to the development and maintenance of infrastructures such as roads, railways, schools, hospitals, and airports. to fund their spending, while corporates count on it for financing long-term investments and short-term operations.
The US Treasury issued Series I BondSeries I BondSeries I Bond is a US Treasury-issued low-risk savings bond. It comes with an annual interest rate derived from a predetermined interest rate and a biannually set inflation rate. and Series EE BondSeries EE BondSeries EE Bond is a savings bond issued by the US Treasury that promises to at least double in value if held for two decades. are two well-known examples of government bondsGovernment BondsA government bond is an investment vehicle that allows investors to lend money to the government in return for a steady interest income.. Corporate bonds have varying attributes and denominations. For instance, they may be short-term or long-term, secured or unsecured, redeemable or irredeemable bonds, junk, or convertible.
The key difference between the two is that government bonds offer lower interest rates, viz-a-viz corporate bonds. However, interests on them are exempt from taxes, making them attractive as a tax-saving instrument for many.
Risks Faced by Bondholders
Bondholders have to deal with the possibility of bond issuers failing to repay the principal or interest. This is referred to as default risk. Since government bonds have the backing of the government, they are less likely to default and are less risker than corporate bonds.
Bondholders also face interest rate risks. When the interest rates of the bonds rise, their prices decline. This is because investors buy bonds that provide a higher interest rate, and hence, the value of the bond issued earlier declines.
Besides the default risk and interest rate risk, bondholders are exposed to inflation risksInflation RisksInflation Risk is a situation where the purchasing power drops drastically. It could also be explained as a situation where the prices of goods and services increase more than expected. Inflation Risk is also known as Purchasing Power Risk.. This means that the bond value may not offset the inflation over the years and hence yield less value at maturityValue At MaturityMaturity value is the amount to be received on the due date or on the maturity of instrument/security that the investor holds over time. It is calculated by multiplying the principal amount to the compounding interest, further calculated by one plus rate of interest to the period's power..
Prospective bondholders should assess the risk of a bond before buying by checking its credit ratingCredit RatingCredit rating process is the process in which a credit rating agency (preferably third party) analyzes a security and rates it accordingly so that the stakeholders can make their investing decisions. published by credit rating agenciesCredit Rating AgenciesCredit rating agencies (CRAs) evaluate and rate the creditworthiness of debt securities and their issuers, including companies and countries. like S&P, Moody’s, and Fitch.
How to Buy Bonds
Bondholders can acquire bonds via:
- Direct purchase through the issuing establishment, or
- Indirect purchase of existing bonds through a monetary authority or dealer on the secondary market.
Thus, a bond is more like a loan agreement between the creditorCreditorA creditor refers to a party involving an individual, institution, or the government that extends credit or lends goods, property, services, or money to another party known as a debtor. The credit made through a legal contract guarantees repayment within a specified period as mutually agreed upon by both parties. (bondholder) and the debtorDebtorA debtor is a borrower who is liable to pay a certain sum to a credit supplier such as a bank, credit card company or goods supplier. The borrower could be an individual like a home loan seeker or a corporate body borrowing funds for business expansion. (corporation). As a result, bondholders enjoy a low-risk investment with a predetermined income. However, potential bond investors must know the interest rate, maturity date, and credit ratings before funding.
Suppose a bondholder holds a bond with a face value of $5,000 and coupon (interest) rate of 5% (paid biannually), and maturity of 20 years.
As long as the bondholder possesses the bond, he will receive an interest of $125 every six months, i.e., $250 annually for 20 years. At the end of 20 years, he may receive the bond’s original value ($5000) back.
Thus, the bondholder gains both from the interest as well as bond redemption. However, if the value of the bond increases in the bond market, the bondholder may choose to sell it at a higher price there and make a profit from it. However, he won’t receive any interest after selling.
A Reuters news report states that US sanctions on Russian sovereign debt are expected to have a limited impact on current bondholders. The recent sanctions imposed include curbs on trading in the rouble and non-rouble-denominated instruments issued after March 1 in the secondary market. However, key debt indexes will continue trading on existing bonds issued and in circulation.
Another news snippet by Reuters talks about a debt reorganization proposal by Brazil’s iron ore miner Samarco Mineracao to rescue itself from bankruptcy. Samarco plans to pay only 25% to its bondholders, providing bonds with maturity in 2041. As per the new proposal, bondholders participating in a supposed capital raise of $1.4 billion may acquire partial refunds with other debt securities.
Bondholder vs Shareholder
The primary difference between bondholders and shareholders is that while bondholders are moneylenders, shareholders are owners. Therefore, shareholders can anchor the company in the desired direction while bondholders are only entitled to fixed interest earnings at the agreed rate and repayment of the principal amount.
However, in the event of bankruptcyBankruptcyBankruptcy refers to the legal procedure of declaring an individual or a business as bankrupt., issuing firms prefer paying up the bondholders before moving on to stockholders. Therefore, corporate bond investment relishes more security than stock investment.
|Owner of bonds issued by a company or government
|Owner of the shares in a company
|Lender or creditor
|Profit from selling bonds at a higher price in the bond market
|Profit from selling securities at a higher price in the stock market
|Biannually or annually
|Return on Investment
|Interest rate risk
|Poor performance of the company
|Low dividend payout
|Refund preference during insolvency
|Receiving interest earnings
Frequently Ask Questions (FAQs)
A – A bond-issuer is a borrower, while a bondholder is a lender. The bondholder lends money to the issuing entity. Then, the bond-issuer is obliged to pay the loaned amount back when the bond matures, along with periodic interest payouts.
A – Shareholder is the owner of stocks in a firm, while the bondholder is a creditor holding government or corporate bonds. Shareholder comes with voting rights, quarterly interest payment, and relatively more return on investment. However, bondholder enjoys a less-risky investment with a fixed premium amount and refund preference during insolvency.
A – Investors who sell their bonds before the maturity date lose the right to fixed interest earnings. Therefore, the buyer or current bondholder is lawfully permitted to obtain the interest payment and redeem the bond at maturity.
A – A bondholder has two crucial rights. The first one is to attain the bond’s principal amount when it matures. Furthermore, the second right is to receive a frequent interest amount (generally bi-annually) at a set percentage of the bond’s value.
This has been a Guide to Bondholder & its meaning. We discuss the rights of bondholders as creditors & compare them with shareholders, along with examples. You may also have a look at the following articles to learn more –