Table of Contents
- Bondholder
- Who is a bondholder?
- Understanding bondholders
- How a bondholder works
- Importance of a bondholder
- Examples of bondholders
- Frequently Asked Questions
Bondholder
A bondholder is an investor who specifically buys or at least holds certain corporate or government bonds. Bondholders are essentially money lenders and they lend money to bond issuers, for which they gain periodic interest payments based on their principal amount.
Buying a bond is seen as a safer alternative due to the fixed nature of the returns it provides. However, it is not immune to the effects of inflation and other risks.
Who is a bondholder?
As the name suggests, bondholders are investors who buy or hold bonds that are issued by a corporate or a government body. To purchase a bond, the investor may contact the bond issuer directly or buy them from a broker on the secondary market. Investors can also buy bonds from the US Treasury when they put new bonds on auction.
However, bondholders can be the owner of the bond, unlike shareholders, but the investor can make claims on the assets of the company in case the company goes bankrupt and its assets are liquidated. In such cases, the company’s assets and proceeds will go to the bondholders first before they make their way to the stockholders.
Understanding bondholders
Bonds are issued by the government or a corporation that’s seeking capital or funds to finance a business or projects. A bondholder will pay a significant amount to purchase the bond for a fixed interest rate that will be paid to the bondholder periodically, and the original bond value will repaid upon maturity. The bond issuer will get the funds it needed to finance new business plans, and the bondholder will periodically get the interest amount and the principal amount upon maturity, a win-win situation for both parties involved.
How a bondholder works
The bondholder is a moneylender who has large funds to buy bonds and finance projects. These bonds once purchased come with a fixed periodic interest rate and repayment of the original capital upon maturity. However, the bondholder may decide to sell the bond to someone else in the secondary market if he gets a better selling price for the bond.
It is not uncommon for a bondholder to buy a bond for some amount and then sell it to someone else for a significantly higher amount. This sale can be done by financial institutions. However, the bondholder will receive no future interest payments once the bond is sold.
The new buyer will be the one who gets all the interest payments from then on, and will also get the full purchase price that was originally paid by the first buyer, upon maturity. Even if the bondholder sells the bond, he still makes a profit as he sold the bond at a much higher price than what he originally paid for the bond.
Importance of a bondholder
- Bondholders earn an easy income with regular and fixed interest rates. On top of that, the capital amount is also returned to the bondholder upon maturity.
- Bondholders make relatively safe investments by buying bonds. Buying bonds directly from the US Treasury is the safest and risk-free investment you can make.
- In case you buy bonds from a corporate and it goes bankrupt, you will receive your share of the payment before the shareholders do.
- Buying municipal bonds provides you with interest payments that won’t be taxed.
Examples of bondholders
The US Treasury bonds, also called T-Bonds, are long-term bonds that mature sometime between 10-30 years and provide a decent interest rate. The interest rate may not be as high as corporate bonds, but the bonds a lot safer and provide zero-coupon securities, allowing trading and price discovery. Then, there are corporate bonds that yield higher interest rates, but lack the risk-free security of government bonds. Also, there are municipal bonds. There are even zero-coupon bonds that don’t provide an interest rate but instead offer steep discounts. So, a $1,000 bond may sell on the secondary market for $900. Buying this bond won’t get you any interest payment, but when it matures, you will get the full $1000 principal value, generating a $100 profit upon maturity.
Frequently Asked Questions
What are the drawbacks of being a bondholders?
Here are some of the drawbacks that bondholders may face in the long run.
- When market rates increase, bondholders may face interest rate risks.
- Depending on the bond issuer’s financial viability, there can be a huge credit risk and default risk. This is a risk facing corporate bonds.
- If inflation grazes the market and manages to exceed the coupon security rate of the bond, then there’s a risk to the face value of your investment.
- The same goes for market interest rates. If interest rates exceed the security coupon rate, the face value of your bond could decrease.
What are the risks to bondholders?
Bondholders must deal with the potential of inflation risk, interest rate risk, and credit risk, among others, that could significantly lower the value of the bond. In extreme cases, the bondholder may also lose money due to the risks involved.
Who are bond issuers and bondholders?
Bond issuers are the ones who sell the original bond. This can be the US Treasury, a corporate, or a local municipality. It’s the bond issuer who decides the face value, interest rate and maturity of the bonds. Bondholders are the individuals who will buy bonds from the US Treasury or a corporate. The bondholder pays the face value of the bond to the bond issuer to purchase the bond.
What is the difference between a bondholder and a shareholder?
Bondholders are individuals who buy bonds of a particular company, while shareholders buy shares of a company. Shareholders become owners of the amount of the shares they purchase, but bondholders are not owners of the bonds.
What are a bondholder’s rights?
A bondholder has two rights. First, to obtain the bond’s principal amount and the second is to obtain the interest rate amount periodically.
