Bonds are issued by governments and corporations to raise capital. Think of it as taking out a loan from investors, who purchase the bonds.
Here's a breakdown of the bond issuance process:
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Issuer's Needs:
- Governments (federal, state, and local) issue bonds to fund public projects, manage debt, or cover budget deficits.
- Corporations issue bonds to finance expansion, acquisitions, research and development, or to refinance existing debt.
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Underwriting:
- The issuer (e.g., a company or government entity) usually hires an investment bank to act as an underwriter.
- The underwriter helps determine the bond's characteristics (e.g., coupon rate, maturity date) and price.
- The underwriter also markets the bonds to potential investors.
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Offering and Pricing:
- The bonds are offered to investors, often through a prospectus (a document that provides details about the bond and the issuer).
- The price of the bond is determined by factors such as prevailing interest rates, the issuer's creditworthiness, and the overall market demand for bonds.
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Distribution:
- The underwriter distributes the bonds to investors, including institutional investors (e.g., pension funds, mutual funds, insurance companies) and individual investors.
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Secondary Market Trading:
- After the initial issuance, bonds can be traded on the secondary market, such as exchanges or over-the-counter (OTC) markets. The price of a bond in the secondary market fluctuates based on supply and demand.
Types of Issuance:
- Public Offering: Bonds are offered to the general public.
- Private Placement: Bonds are sold directly to a limited number of sophisticated investors.
Key Bond Characteristics Determined at Issuance:
- Face Value (Par Value): The amount the issuer will repay at maturity.
- Coupon Rate: The annual interest rate the issuer pays to the bondholder, expressed as a percentage of the face value.
- Maturity Date: The date when the issuer will repay the face value of the bond.
- Credit Rating: Assigned by agencies like Moody's or Standard & Poor's, indicating the issuer's creditworthiness and risk of default. Higher ratings generally mean lower risk and lower interest rates for the issuer.
In summary, bonds are issued to raise money, with the issuer promising to repay the principal amount (face value) at maturity and make periodic interest payments (coupon payments) along the way. Investment banks facilitate this process by underwriting and distributing the bonds to investors.
