The precise bond definition and meaning is: “bond is a security representing the debt of the company or government issuing it“.
When a company or government issues a bond, it borrows money from the bondholders; it then uses the money to invest in its operations. In exchange, the bondholder receives the principal amount back on a maturity date stated in the indenture, which is the agreement governing a bond’s terms. In addition, the bondholder usually has the right to receive coupons or payments on the bond’s interest.
Generally speaking, a bond is tradable though some, such as savings bonds, are not. The interest rates on Treasury securities are considered a benchmark for interest rates on other debt in the United States. The higher the interest rate on a bond is, the more risky it is likely to be.
To have a full overview of the bond definition you have to know that bonds are issued by public authorities, credit institutions, companies and supranational institutions in the primary markets.
The most common process for issuing bonds is through underwriting.
When a bond issue is underwritten, one or more securities firms or banks, forming a syndicate, buy the entire issue of bonds from the issuer and re-sell them to investors. The security firm takes the risk of being unable to sell on the issue to end investors.
Primary issuance is arranged by bookrunners who arrange the bond issue, have direct contact with investors and act as advisers to the bond issuer in terms of timing and price of the bond issue. The bookrunner is listed first among all underwriters participating in the issuance in the tombstone ads commonly used to announce bonds to the public. The bookrunners’ willingness to underwrite must be discussed prior to any decision on the terms of the bond issue as there may be limited demand for the bonds.
In contrast, government bonds are usually issued in an auction. In some cases, both members of the public and banks may bid for bonds. In other cases, only market makers may bid for bonds. The overall rate of return on the bond depends on both the terms of the bond and the price paid.
The terms of the bond, such as the coupon, are fixed in advance and the price is determined by the market. In the case of an underwritten bond, the underwriters will charge a fee for underwriting. An alternative process for bond issuance, which is commonly used for smaller issues and avoids this cost, is the private placement bond. Bonds sold directly to buyers may not be tradeable in the bond market.
To be more detailed on the bond definition we decided to give you a concrete example of how does it work the process of issuing of a bond. When a government or business — think the United States government, or the city of Philadelphia, or Procter and Gamble — needs to raise money, they may decide to issue a bond. A bond is always issued with a certain face amount, also called the principal, also called the par value of the bond. Most often, simply because it is convention, bonds are issued with face amounts of $1,000. So in order to raise $50 million, they would have to issue 50,000 bonds each selling at $1,000 par. Of course, they would then have to go out and find investors.
So if a corporation or government issues a $1,000 bond, paying 6 percent, that corporation or government promises to fork over to the bondholder $60 a year — or, in most cases, $30 twice a year. Then, when the bond matures, the corporation or government gives the bondholder his or her $1,000 back.
In some cases, you can buy a bond directly from the issuer and sell it back directly to the issuer, but in most cases, bonds are bought and sold through a brokerage house or a bank. These brokerage houses take a piece of the pie, sometimes a quite sizeable piece.
We hope the bond definition we gave you has been exhaustive, helpful and useful to you.