Question

Based on your understanding of bond, determine the type of loan that a bond most resembles and state your reasons.

Answer 1

Bond is a financial instrument bearing fixed rate of interest which is paid to the investor by bond issuer in exhange of the amount as a loan for a fixed time period. Bond mostly resembles corporate loans borrowed by a company or even by government to aquire capital to be invested in capital intensive projects. In exchange of the amount company pays periodic interest to the investors.

Raising capital through bonds are less expensive as compared to the capital raised to equity or loan taken from banks. Banks usually charge high rate of interest on the corporate loan, therefore company raise capital through issuing bonds. Raising capital through equity is also expensive as dividends are paid to shareholders which is more expensive than interest on bonds. Thus, company or government issue bonds to aquire capital for long-term capital intensive projects.