Bondholder

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21 Aug, 2024

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Bondholder Meaning

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 risks to weigh the real gain from it. Unlike shareholders, they are not owners. However, they have a prior claim over a company's assets in the event of liquidation. An investor may purchase bonds either directly from the issuing body or on the secondary market via an agent.

Bondholder Meaning

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.

Bondholder Explained

A bondholder denotes a moneylender offering funds to the bond-issuing entity. Bonds are debt instruments 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 instruments and hence can be traded in secondary markets. 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 bonds. National or local government issues government or municipal bonds to fund their spending, while corporates count on it for financing long-term investments and short-term operations.

The US Treasury issued Series I Bond and Series EE Bond are two well-known examples of government bonds. 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 risks. This means that the bond value may not offset the inflation over the years and hence yield less value at maturity.

Prospective bondholders should assess the risk of a bond before buying by checking its credit rating published by credit rating agencies 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 creditor (bondholder) and the debtor (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.

Examples

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 bankruptcy, issuing firms prefer paying up the bondholders before moving on to stockholders. Therefore, corporate bond investment relishes more security than stock investment.

Particulars	Bondholder	Shareholder
Definition	Owner of bonds issued by a company or government	Owner of the shares in a company
Status	Lender or creditor	Proprietor
Decision-making process	Not included	Included
Earning prospects	Interest payment	Dividend
	Profit from selling bonds at a higher price in the bond market	Profit from selling securities at a higher price in the stock market
Interest/Dividend payout	Biannually or annually	Annually
Voting rights	Denied	Granted
Return on Investment	Comparably lesser	Comparably more
Related risks	Interest rate risk	Poor performance of the company
	Inflation risk	Low dividend payout
	Default risk	Market instability
Refund preference during insolvency	First priority	Preferred shareholders	Second priority
		Common shareholders	Third priority
Risk prospects	Comparably lower	Comparably higher
Investment objective	Receiving interest earnings	Capital appreciation

Frequently Ask Questions (FAQs)

Q#1 – Who are bond-issuer and bondholder?

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.

Q#2 – What is the difference between a bondholder and a shareholder?

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.

Q#3 – What if I sell my bonds early?

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.

Q#4 – What are a bondholder’s rights?

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.