If we are to make a significant investment – if we want to buy a car, an apartment or a house for example – it may well be that the money we have saved up is not sufficient. We will then contact our bank to borrow money that we subsequently pay back over a more or less long period.
Sometimes the loan required is so high that one single bank has not sufficient funds to provide it or does not want to take all risk associated with such a high credit. This may for instance be the case if a company wants to finance the construction of a new factory, if a municipality needs money for a new housing project or if a government wants to build a new highway.
Let’s take the example of a company that needs 500 million euros to build a new factory. It probably will not find any bank that will lend it the entire sum. Instead of trying to borrow the total 500 million euros from a single bank, the company may decide to look for a much higher number of shoulders to bear the burden of this big loan and to ask hundreds, if not thousands of savers to lend it a small portion of the needed amount.
For this purpose, the company will launch a bond. It will split the 500 million euros into, let’s say, 100,000 tranches of 5,000 euros each and creates 100,000 bonds, worth 5,000 euros each. A bond is a promissory note that can be purchased by investors. In our example, this promissory note has a nominal value of 5,000 euros.
The company that has issued these bonds (the “issuer”) commits to pay interest regularly (usually once a year) to those who buy the bonds and to repay the nominal value (in our example: EUR 5,000) to the bond holders after a pre-determined period of time (usually after several years).
Thus a bond represents a debt of its issuer towards the holder of the bond. By acquiring a bond issued by a company, the investor is lending money to the company over a certain period of time. However, if he buys a stock of the company, he acquires a part of the company and becomes a co-owner (“shareholder”) of the company.