Introduction to bonds | Stocks and bonds | Finance & Capital Markets | Khan Academy

Summary

This video explains bonds as a method for companies to raise funds by borrowing from multiple entities instead of banks. It contrasts bond financing with equity financing, highlighting the fixed interest payments (coupons) and the eventual repayment of the bond's face value. The video uses a hypothetical company with $10 million in assets and no liabilities to illustrate how issuing bonds can expand the company without diluting ownership. The concept of bond maturity and semi-annual coupon payments is also discussed.

Takeaways

• 💼 A bond is a debt security, allowing investors to lend money to a company.
• 🏢 Companies issue bonds to raise capital for expansion or other purposes without selling equity.
• 💹 Issuing bonds involves borrowing money, which appears as a liability on a company's balance sheet.
• 📈 When a company issues more equity, it increases the number of shareholders and dilutes existing ownership.
• 💰 The decision to issue bonds or equity depends on the company's financial strategy and market conditions.
• 📉 Bonds are attractive to investors because they offer fixed interest payments and the return of principal at maturity.
• 📚 The term 'coupon' originates from the physical coupons that bondholders would clip and exchange for interest payments.
• 🌐 In the US and Western Europe, bond coupons are typically paid semi-annually.
• 💵 The face value of a bond, often $1,000, represents the amount that will be repaid at maturity.
• 📅 Bonds have a maturity date, which is the point at which the bond issuer repays the principal and the final coupon payment is made.

Q & A

What is the basic concept of a bond as described in the video?

A bond is a financial instrument that allows an individual or entity to lend money to a company, effectively becoming a partial lender.

How does a company's equity change if it issues more shares to finance its expansion?

If a company issues more shares to finance its expansion, its equity increases by the amount of money raised, but the number of shareholders also increases, diluting the ownership of each share.

What is the alternative to issuing equity that the video discusses for financing company expansion?

The alternative to issuing equity for financing company expansion is borrowing money, which can be done by taking a loan from a bank or issuing bonds to multiple entities.

What is the difference between equity financing and debt financing as per the video?

Equity financing involves issuing new shares, which increases the number of owners and requires sharing profits with them. Debt financing, such as issuing bonds, involves borrowing money where the lenders receive interest payments but do not share in company profits.

Why might a company choose to issue bonds instead of getting a loan from a single bank?

A company might choose to issue bonds instead of getting a loan from a single bank to spread the risk among many lenders, making it more manageable and potentially more appealing to a wider range of investors.

What is the term used for the face value of a bond, and what does it represent?

The term used for the face value of a bond is 'par value', and it represents the amount that will be paid back to the bondholder at the bond's maturity.

What is an annual coupon payment on a bond, and how does it relate to the bond's interest rate?

An annual coupon payment is the annual interest payment made to bondholders, calculated as a percentage of the bond's face value. For example, a 10% annual coupon on a $1,000 bond means a $100 interest payment per year.

How often are coupon payments typically made, and why?

Coupon payments are typically made semi-annually. This practice allows for a steady stream of income for bondholders and spreads the company's interest expense over the year.

What is the maturity date of a bond, and why is it significant?

The maturity date of a bond is the date when the bond reaches its end and the issuer must pay back the full face value to the bondholder. It is significant as it marks the end of the bond's term and the final payment of principal.

How does the video explain the process of a company raising $5 million by issuing bonds?

The video explains that a company can raise $5 million by issuing bonds with a face value of $1,000 each, promising to pay an annual 10% coupon and maturing in two years. To reach $5 million, the company would need to issue 5,000 bonds.

What happens to a company's balance sheet when it issues bonds instead of equity to finance its expansion?

When a company issues bonds, its assets increase by the amount of money raised, but instead of increasing equity, the company's liabilities increase by the same amount, reflecting the debt it has taken on.