There are various ways to raise capital, but why do companies issue bonds and what is their objective in doing so? Whether you’re an investor interested in economic activities or seeking to attract capital for the launch or expansion of your own business or company, it will be useful for you to understand the goals for which bonds are issued. FFMag addresses your questions in this regard.
What is Bond Issuance?
Bonds are financial instruments through which capital is transferred as a loan between investors and the recipient company, and based on this, the investor commits a specified amount of financial assets or money for a specified and particular period to the target company. In return, the company commits to paying dividends to the investor over defined periods. At the end of the contract period, the principal amount is returned to the lender. This explanation somewhat indicates why companies issue bonds.
Simultaneously with the issuance of these financial instruments, the issuers also declare the “nominal value” of these documents to buyers and investors. The concept of nominal value refers to the amount that the buyer or holder of the bond will receive, and this will continue until the issuer redeems it.
However, it should be noted in this regard that the nominal value of bonds does not necessarily reflect their actual value, and the price of these securities sometimes changes in the secondary market due to reasons such as supply and demand, interest rates, and other factors. For this reason, bonds may be traded at a price lower than their nominal value, i.e., below par, in the secondary market, and if the requested price is higher than the nominal value, they are offered with a premium.
Advantages of Bond Issuance
If we can fully understand the benefits and advantages that the issuance of bonds brings to individuals or companies, we will be able to unveil the purpose of companies in issuing such securities. Some of these benefits include:
Offering bonds and having an active market for them helps investors find a reliable source and reference to put their capital into circulation, indirectly engaging in economic activities, and achieving significant profits.
Publishing these financial instruments helps reduce the risks arising from the performance of banking systems and acts as an effective factor in stabilizing economic conditions.
Such financial documents can play an effective and efficient role in the economy, providing financial resources while being cost-effective. Now let’s move on to the reasons why companies issue bonds.
Why Companies Issue Bonds
Various reasons can be cited to answer this important question and tell us what the purpose of issuing such bonds might be. FFMag will now address some of these reasons:
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Capital Increase
The main reason companies issue these financial instruments is to attract a large amount of capital to meet their economic needs, expand the scope of their activities, access new markets, or launch new divisions or produce new products. They do this to gain access to new resources without losing or reducing their ownership stake.
Paying Lower Interest
To understand why companies issue bonds, we need to focus on the important topic of interest rates. The interest rate for bonds is lower than the returns demanded by equity investors; therefore, this avenue is more cost-effective for company owners. Additionally, due to the payment of bond interest to investors, these amounts are deducted from the company’s taxes, providing significant financial assistance to them.
Securing Resources for Important Projects
When various companies are considering launching or realizing specific and important projects, they issue bonds to secure the necessary financial resources. This allows them to reduce their tax liabilities and benefit from the money of others to advance their goals.
Relief from Current Debts
Repaying existing financial debts and paying their interests can be burdensome and a serious hindrance to all companies. However, by receiving funds from others, they can issue bonds at lower interest rates and settle high-interest debts more quickly. This is called refinancing, which is considered a rational and cost-effective approach.
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Flexibility in Bond Issuance Conditions
Obtaining financial resources from any source has its own challenges and limitations. For example, obtaining a bank loan comes with specific contractual and legal constraints. However, when a company decides to issue bonds, it has the opportunity and flexibility to define the terms and conditions according to its needs and objectives.
Determining an Appropriate Maturity Date
When we know that issuers of these bonds are allowed to set multiple maturity dates for financial instruments they issue, we fully understand why companies issue bonds. They address different dates to align them with their long-term financial needs and mitigate risks associated with liquidity threats.
Attracting Investors through Diverse Avenues
When the issuance of bonds comes into play, companies can offer them in various arenas and markets to attract capital from diverse groups and investors. This expands their financial bases and ensures they are not solely reliant on limited and specific resources.
Summary
One common method for capital acquisition by economic entities is the issuance of financial instruments, which they receive in exchange for commitments to investors. FFMag lists reasons why companies issue bonds, including: increasing capital, paying lower interest, securing resources for important projects, relief from current debts, flexibility in bond issuance conditions, determining an appropriate maturity date, and attracting investors through diverse avenues.
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By David Taha