They're similar, but definitely not the same.
When companies need to raise money to continue or expand their operations, they generally have the option to choose between long-term loans and bonds. Long-term loans and bonds work in a similar fashion. With each financing option, a company borrows money that it agrees to repay at a certain time and at a predetermined interest rate.
When a company takes out a loan, it is typically borrowing money from a bank. Though repayment terms can vary, typically, a company that borrows money will make periodic principal plus interest payments to its lender over the life of the loan.
Bonds are similar to loans, only instead of borrowing money from a bank or single lending source, a company instead borrows money from the public. With bonds, the issuing company makes periodic interest payments to its bondholders, usually twice a year, and repays the principal amount at the end of the bond's term, or maturity date. There are benefits and drawbacks to each of these financing options.
Advantages of bonds
When a company issues bonds, it is generally able to lock in a long-term interest rate that is lower than the rate a bank would charge. The lower the interest rate for the borrowing company, the less the loan ends up costing.
Additionally, when a company issues bonds instead of pursuing a long-term loan, it generally has more flexibility to operate as it sees fit. Bank loans tend to come with certain operating restrictions that could limit a company's ability to grow physically and financially. For example, some banks prohibit their borrowers from making further acquisitions until their loans are repaid in full. Bonds, by contrast, do not come with operating limitations.
Finally, some long-term loans are structured to include variable interest rates, which means a company's rate could go up significantly over time. When a company issues bonds, it is able to lock in a fixed interest rate for the life of the bonds, which could be 10 years, 20 years, or more.
Advantages of long-term loans
Unlike bonds, the terms of a long-term loan can often be modified and restructured to benefit the borrowing party. When a company issues bonds, it is committing to a fixed payment schedule and interest rate, whereas some bank loans offer more flexible refinancing options.
Furthermore, obtaining a bank loan is generally less of an administrative hassle than going through the process of issuing bonds. To sell bonds to the public, the issuing company must spend time and money on advertising while taking steps to ensure that it adheres to SEC requirements. The costs of obtaining a bank loan can therefore be significantly lower than the costs involved in borrowing money through bonds.
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FAQs
Unlike bonds, the terms of a long-term loan can often be modified and restructured to benefit the borrowing party. When a company issues bonds, it is committing to a fixed payment schedule and interest rate, whereas some bank loans offer more flexible refinancing options.
Which is a correct difference between bonds and loans? ›
Bonds allow for longer payment periods while loans are usually of a shorter tenure. Are the two means of funding equally flexible? Loans are tailored according to the company's interests and can change as the company evolves.
Why choose a bond over a loan? ›
To start, bonds usually have a lower interest rate than loans. However, loans are a reliable and secure choice for financing since the monthly payments don't fluctuate with interest rate changes. In addition, a loan doesn't come with a huge payment at the end of the repayment term.
How does a bond differ from term in loans? ›
A bond differs from a term loan in that: A bond issue is negotiated between a financial institution and an investor. A bond is sold to a financial institution only. A bond is always offered to the public at a variable coupon rate.
What are the 3 major disadvantages in using bonds for long-term financing? ›
Some of the disadvantages of bonds include interest rate fluctuations, market volatility, lower returns, and change in the issuer's financial stability. The price of bonds is inversely proportional to the interest rate. If bond prices increase, interest rates decrease and vice-versa.
Is a bond basically a loan? ›
By buying a bond, you're giving the issuer a loan, and they agree to pay you back the face value of the loan on a specific date, and to pay you periodic interest payments along the way, usually twice a year. Unlike stocks, bonds issued by companies give you no ownership rights.
What is one advantage of bonds over loans? ›
Issuing bonds also gives companies significantly greater freedom to operate as they see fit. Bonds release firms from the restrictions that are often attached to bank loans. For example, banks often make companies agree not to issue more debt or make corporate acquisitions until their loans are repaid in full.
Why do loans recover more than bonds? ›
Bank loans are typically more highly collateralized than bonds at origination ; Banks can intervene in the affairs of a borrower at an early stage of developing credit risk ; Banks have the option to seek more or better collateral on existing loans or reduce the exposure when a borrower's breached the contract; and.
What is the biggest advantage of borrowing money such as a loan or bond instead of issuing stock in order to raise capital? ›
Answer and Explanation: The biggest advantage of borrowing money instead of issuing stock is the tax benefit. Interest on debt securities, like loans or bonds, is tax deductible. This means that companies can reduce their taxable income by the amount of interest paid on their debt.
Should you buy bonds when interest is high? ›
Should I only buy bonds when interest rates are high? There are advantages to purchasing bonds after interest rates have risen. Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels.
Higher Interest Rate (Cost of Capital)
A fixed interest rate is more common for riskier types of debt, such as high-yield bonds and mezzanine financing. Since bonds come with less restrictive covenants and are usually unsecured, they're riskier for investors and therefore command higher interest rates than loans.
Why do investors prefer bonds? ›
Investors buy bonds because: They provide a predictable income stream. Typically, bonds pay interest on a regular schedule, such as every six months. If the bonds are held to maturity, bondholders get back the entire principal, so bonds are a way to preserve capital while investing.
Are bonds better for long-term or short term? ›
All else being equal, a bond with a longer maturity usually will pay a higher interest rate than a shorter-term bond. For example, 30-year Treasury bonds often pay a full percentage point or two more interest than five-year Treasury notes.
How is a CD different from a bond? ›
Bonds often offer higher interest rates than CDs, which may be appealing to those looking for a higher profit potential. Unlike CDs, where interest may accumulate and only be paid at maturity, bonds often provide ongoing interest payments, usually at monthly or quarterly intervals.
What is the difference between a term loan and a high yield bond? ›
Both high yield bonds and loans are below-investment-grade debt, but loans are senior in a company's capital structure (they get paid back first in a restructuring) and are secured by a company's assets. High yield bonds are often further down in the capital structure and generally not secured by a company's assets.
What is the main difference between a bond and a long-term note? ›
Bonds are long-term securities that mature in 20 or 30 years. Notes are relatively short or medium-term securities that mature in 2, 3, 5, 7, or 10 years. Both bonds and notes pay interest every six months. The interest rate for a particular security is set at the auction.
Is bond a long-term borrowing? ›
Bonds payable
A bond is a long-term debt, or liability, owed by its issuer. Physical evidence of the debt lies in a negotiable bond certificate.
Are bonds considered long-term debt? ›
Corporate bonds are a common type of long-term debt investment. Corporations can issue debt with varying maturities. All corporate bonds with maturities greater than one year are considered long-term debt investments.
Are bonds better for long-term? ›
All else being equal, a bond with a longer maturity usually will pay a higher interest rate than a shorter-term bond. For example, 30-year Treasury bonds often pay a full percentage point or two more interest than five-year Treasury notes.
