What is a bond and how does it differ from a loan?

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What is a bond and how does it differ from a loan?

In: Economics

5 Answers

Anonymous 0 Comments

It is not different, in the sense that it is a **kind** of loan.

A loan is any agreement where I give you something (usually money) and you promise to give it back (in the case of money, usually with “interest,” which is my profit on the transaction). We might also set a time period for that pay-back, and that’s called the “term” for the loan.

If I am concerned you might not pay back the loan, I might insist that it be backed by some kind of security or collateral. For instance, you might agree that if you don’t pay back your loan on time, you have to give me your car instead.

The details of bonds vary but they should have all three of those elements for the loan — an interest rate, a term, and a security or collateral. In general, a bond is a loan of money upfront, with the promise that you will pay it back at the end of the term, pay me interest each year in the meantime, and if you go bankrupt before you’ve paid me back, I get a place near the front of the line for any of the assets you have left that can be sold off to settle your debts. This means that if the company collapses, there’s still a chance I’ll get some of my money back.

This last part matters in an investment context because it is in direct contrast to the people who own shares or equities (“stock” in the company). In the event of bankruptcy, the shareholders usually get put last in line, which means that by the time it’s their turn for a share of the remaining assets, there are almost never any assets left. When the company goes bankrupt, they get wiped out.

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