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WHAT IS A BOND AND HOW DOES IT DIFFER FROM OTHER FINANCING OPTIONS?

A bond is a form of debt security. A debt security is a legal contract for money owed that can be bought and sold between parties.

Entities seeking financing have two basic options to raise funds: stocks (equities) and bonds. Bonds are a form of debt, whereas stocks are a form of ownership.

Investors in bonds become creditors of the issuing entity. They are paid a fixed interest rate (coupon) and returned their initial investment (principal) upon maturity. Because bonds typically pay a fixed interest over the maturity period, they are often referred to as fixed-income securities. Once purchased from the issuer (through financial institutions acting as dealers), bonds can continue to be traded in the securities market.

Investors in stocks, on the other hand, purchase a portion of the issuing firm. Therefore, the returns of their investment fluctuate in accordance with dividends paid by the issuing firm and the value of the issuing firm. Stocks are also traded in the securities market.

HOW DO CREDIT RATINGS RELATE TO THE RISK-RETURN FUNDAMENTAL OF INVESTING?

Investors seek returns commensurate to the risk of investment opportunities.

Many investors have mandated thresholds for risk tolerance and often compare risk-adjusted returns to a benchmark or reference. In judging risks of various investment opportunities, including assessing the creditworthiness of bond issuers, investors use their own due diligence and other sources, such as credit ratings by the rating agencies (for example, Fitch, Moody’s, or Standard & Poor’s).

WHY DO INVESTORS SOMETIMES CHOOSE BONDS OVER OTHER INVESTMENT OR SAVING OPPORTUNITIES?

An investor may choose to invest in the bond market over other alternatives for several reasons.

Fixed-rate bonds offer fixed returns over a fixed time, in fixed periodical installments. This generally makes for a more predictable, less risky investment than other investment options. This higher predictability of cash flows makes bonds a good counterbalance to riskier, more volatile elements in an investment portfolio.

WHAT ARE THE REQUIREMENTS, AND WHO CAN ISSUE BONDS? (PRIVATE AND PUBLIC EXAMPLES)

Issuers of bonds can be private companies, supranational institutions (such as multilateral banks), and public entities (municipal, state, or federal).

Issuing bonds is a complex process involving several steps to meet requirements of specific markets and countries of issuance. Figures 1 and 2 present examples of corporate bond issuance requirements in Brazil and China, respectively. Continue >

WHAT IS THE CONTEXT OF BONDS IN GLOBAL FINANCIAL MARKETS?

Globally, financial markets—both equity and debt—were worth US$212 trillion in 2010, with bonds reaching about US$93 trillion or 44 percent of the total.

The largest markets were in the United States (32 percent), Western Europe (30 percent), Japan (12 percent), and other regions, as shown in figure 3. Emerging financial markets account for about 17 percent and are growing fastest, particularly in China and India. Continue >