Who is a Bondholder?
A bondholder is an individual or entity that invests in or owns bonds. Holding debt securities issued by corporations and governments, bondholders essentially lend money to these entities in exchange for certain financial returns. Upon a bond’s maturity, bondholders receive their initial investment back. Generally, bondholders also receive periodic interest payments over the life of the bond.
Key Takeaways
- A bondholder is an investor who acquires bonds issued by governmental bodies or corporations.
- They essentially become creditors to the issuer, so bondholders enjoy certain protections and priority over equity holders.
- Bondholders receive their principal back at maturity, plus periodic interest payments in most cases.
- Profits can also be made if the bonds appreciate in value and are sold on the secondary market.
Understanding Bondholders
An entity investing in bonds is referred to as a bondholder. Investors purchase bonds directly from various entities, including federal, local governments, and corporations. For example, prospective bondholders can buy Treasury bonds from the U.S. Treasury during auctions.
Bonds are typically issued to raise funds for specific purposes, such as government infrastructure projects or corporate expansion. Bondholders invest upfront capital, and in return, receive their principal back upon maturity. They may also receive periodic interest payments.
Bond investments are generally safer than stocks, primarily because, in the event of bankruptcy, bondholders have a higher claim on the company’s assets. However, this safety depends on the issuing entity’s solvency, as bonds carry credit and default risks.
Bondholder Specifics
Several vital areas must be understood when investing in bonds, given their unique nature when compared to stocks.
Interest Rate
The coupon rate is the interest rate paid by the issuer to the bondholder. It can be fixed or floating, tied to benchmarks like the 10-year Treasury bond yield. Some bonds, called zero-coupon bonds, are sold at a discount instead of paying regular interest, providing profit at maturity.
Maturity Date
Maturity is when the issuer repays the principal to bondholders. While most government securities repay principal at maturity, corporate bonds have varied repayment schemes, such as lump sum or debenture redemption reserve. Callable bonds can be redeemed before the stated maturity, ending future interest payments.
Credit Ratings
The credit rating of the issuer/bond affects the interest rate received by investors. Agencies like Standard & Poor’s provide ratings ranging from AAA (excellent) to C and D (higher risk), guiding investors on the investment’s risk.
How Bondholders Earn Income
Earned Income
Bondholders typically earn income through periodic interest payments structured semi-annually, annually, quarterly, or monthly. Additionally, they can sell bonds on the secondary market, potentially earning profits if bond values increase.
Taxation
Certain bonds, like municipal bonds, offer tax exemptions on earned interest. Triple-tax-free bonds even avoid state, local, and federal taxes if the investor resides in the issuing municipality.
Rewards and Risks for Bondholders
Rewards
- Receive regular interest payments and return of principal at maturity.
- Lower risks compared to stocks, with fixed-income guarantees.
- Priority repayment rights in corporate bankruptcy scenarios.
- Potential tax benefits.
Risks
- Interest payments may not outpace inflation, leading to real-term losses.
- Fixed-rate bonds may underperform in rising interest rate environments.
- Corporate bonds carry higher default and credit risks than government bonds.
- Secondary market values can fluctuate based on various economic factors.
Examples of Bondholders
Government Bonds
U.S. Treasury bonds are low-risk investments issued by the U.S. government. They offer semiannual interest payments and typically become profitable upon selling or maturity.
Corporate Bonds
Companies like Microsoft issue long-term bonds, often with attractive yields due to inherent investment risks. These bonds are traded on secondary markets.
Rights of Bondholders
Bondholders have the right to full principal repayment at maturity and timely interest payments according to the bond terms.
Government vs. Corporate Bonds
Government bonds are generally safer and backed by the full faith of the issuing body. Corporate bonds can be slightly riskier but offer higher yields. Government bonds are less prone to default than corporate bonds, though bondholders have repayment priorities over shareholder payouts in corporate bonds.
Can You Lose Money on Bonds?
Yes, bonds carry risks like inflation, tax liabilities, and potential devaluation, resulting in possible financial losses.
The Bottom Line
Though bonds are typically considered safe investments providing fixed incomes, it is important for investors to understand key elements such as interest rates, maturity dates, and credit ratings before investing. Awareness of associated risks like inflation and regulatory changes is essential for making informed decisions.
Related Terms: bond, maturity, coupon rate, credit risk, default risk, interest rate risk, inflationary risk.
References
- Investor.gov. “Bonds”.
- FINRA. “Understanding Bond Yield and Return”.
- TreasuryDirect.gov. “Frequently Asked Questions on Floating Rate Notes (FRNs)”.
- Investor.gov. “Zero Coupon Bond”.
- National Council of Educational Research and Training. “Issue and Redemption of Debentures”, Pages 111–112.
- The Investors Book. “Debenture Redemption Reserve”.
- Investor.gov. “Callable or Redeemable Bonds”.
- The Association of Corporate Treasurers. “Corporate Credit Ratings: A Quick Guide”.
- Fitch Ratings. “Fitch Downgrades the United States’ Long-Term Ratings to ‘AA+’ from ‘AAA’; Outlook Stable”.
- U.S. Securities and Exchange Commission. “What Are Municipal Bonds”.
- New York City Comptroller Brad Lander. “NYC Bonds.”
- Merrill, A Bank of America Company. “Understanding Bonds and Their Risks”.
- TreasuryDirect. “Treasury Bonds”.
- FRED Economic Data. “Market Yield on U.S. Treasury Securities at 30-Year Constant Maturity, Quoted on an Investment Basis”.
- Börse Frankfurt. “Microsoft Corp. 4,875% 13/43”.
