In the context to loans and bonds, the material that we have carefully included is the easiest that you can refer to. The commitment of a lender is denoted in a loan that is obtained. The predicated amount of money that you get on one or more time in the upcoming future (i.e., maturity). The interest that you pay is in surplus to the cash that was loaned or borrowed. The difference that is made out in the interest value is what that the lender surpluses or profits from you. Bond is rather that sort of loan that you obtain which “binds” or compels you to pay the loaned amount. For any investor, “extending a loan to you” means “buying a bond”. Bond purchase is hence the process where the loan lender gives you cash in exchange of a promise that you will pay the loaned money with interest amount in future. This works similarly in the case of a firm too. Bonds and loans are sometimes referred to as a fixed income source. This is as the bond that is formed is a “promise” that a fixed sum amount of payment can be expected by the loan giver.
You must hence view bond formation as categories of investment – the money that goes in is the money coming out. In the upcoming chapter 5, readers will be taught more on the topic of treasuries, these are bonds which are issued by U.S. Treasury department. The majestically alluring feature of bonds like these is this that you will always be aware of what certain cash flow stands up to be. Plus, a lot of economy remains closely linked to the loans and bonds which are associated with the bonds. Thus, this makes the bonds so important. Understanding the entire concept thus becomes useful.
You must already know the total return that is formed is an interest. The rate of return that you get on any loan is an interest rate – however, we will brush up your concept and knowledge that is to be found about these interest rates. The main and only difference that is made in between the non-interest payment mode along with the interest inclusive loan is that these are later working like that of a maximum value of payment. Though, the non-interest loan payment has an increment potential. Though the previous statements hold true, not all the rates of return is the interest rate. Here is an example: investment made in lottery tickets is not accounted or assumed as a loan. Thus, this will not offer any interest rate. What it offers is a simple rates of returns. In the reality driven life, the payoff amount of it is uncertain – extending from the zero to unlimited money amount. This same theory hence applies to the stock market as well as various corporate projects. In a lot of our phrases, you will be able to notice the term “interest rate”, however, what is referred to in those examples as is the rate of return.
So a question arises: buying a money bond of $1000 or investing the same amount in a savings bank account – which is better? Rather is there any particular difference? As it appears, there is. However, the difference is a minute one. Bond investment will be defined by the future payoff that you are supposed to receive in the future. Thus it entirely depends on the future payoffs. Being a bond owner, one can make out the exact value that is to be yours the next year. A bank investment however, is thus defined by the investments that are done by you today. The proper exact amount may depend on the future upcoming interest rates. This is for a proper example: it can be $1080 or $1120 too. This depends on whether the interest rates have decreased or increased.
You can imagine the savings bank accounts as the 1-day plan bond: if you deposit the cash, you get a single day bond. Which is for such a condition, the one day interest rate is known in advance. The money is automatically reinvested the next or upcoming day. The investment is thus again invested into a different bond with the existing interest rate that is dealt with the previous day.
Links of Previous Main Topic:-
- Introduction of corporate finance
- A the law of one price
- Investments projects and firms
- Firms versus individuals
- The time value of money and net present value
Links of Next Financial Accounting Topics:-
- Loans and bonds
- Returns net returns and rates of return
- The time value of money future value and compounding
- Present values discounting and capital budgeting
- Net present value