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- Bonds are debt securities issued by an authorized issuer that owes debt to holders and pays interest for the use of the principal. A bond represents a contract to pay off the money borrowed and in that, it is a debt investment. Investors loan money to government or corporate entities which borrow the funds for a specified period and at fixed interest. The US government, states, municipalities, and various companies use bonds to finance different activities and projects. Bonds are a fixed-income security and one of the major asset classes, together with cash equivalents and stocks. There are various types of bonds, including notes and bills, municipal bonds, corporate bonds, and U.S. Treasury bonds. In general, bonds are defined by two features, duration and credit quality, which determine the interest rate of bonds. Bond maturities vary widely – from 30-year government bonds to 90-day Treasury bills.
Like stocks, bonds are securities, but there is one important difference between the two. Stockholders are the owners of a company and have equity in it while bond holders are lenders, with creditor stake in a company, establishment, or another entity. In addition, bonds have maturity or a specified term after which they are redeemed. Stocks, on the other hand, can be outstanding for an indefinite period of time.
Basically, bonds are similar to loans and help borrowers make long-term investments. Government bonds are used to finance current expenditure. It is important to note that commercial paper (fixed-maturity unsecured promissory note) and certificates of deposit are not bonds but money market instruments.
Treasury bonds are debt securities that pay fixed interest until maturity. Interest is paid every 6 months, and bonds are issued with up to a 30-year term. Treasury bonds or T-Bonds are a US government debt security instrument with income being taxed at the federal level only. The minimum denomination of treasury bonds is $1,000. They are first sold through action and then can be traded on the secondary market.
Corporate bonds are a type of bonds issued by corporate entities. Corporate bonds are issued to raise capital and expand business corporations. They are normally long-term debt securities, with a term of one or more years after the date of issue. Commercial paper is another term used for debt instruments with a shorter term. In general, corporate bonds are sold to investors and backed by the company’s payment ability. This is usually money expected to be earned from future projects and operations of the company. The physical assets of corporations are sometimes used as collateral. Note that corporate bonds carry higher risk compared to government bonds. They go with a higher interest rate for this reason. This type of debt financing is a main capital source for many business entities, together with lines of credit and bank and equity loans. Companies that can show a consistent potential for earning offer debt securities at an attractive coupon rate.
Municipal bonds are another variety of bonds issued by local government structures. They are issued by local government entities and their respective agencies. Among the issuers of municipal bonds are counties, cities, school districts, special-purpose districts, publicly owned airports, redevelopment agencies, and others. Municipal bonds are secured by issuers by specified revenues. The interest income that holders receive in the US is oftentimes exempt from income tax and federal income tax, but not all bonds are exempt, depending on their purpose. Price restrictions apply to new issue stocks, but once they are bought by investors, bonds can be traded any time. The same bonds may be re-traded several times a week by professional investors.