A Bondholder is someone who is an investor or the owner of debt securities (a type of loan) that are generally issued by corporations and governments to people.
Those people are referred to as bondholders and Bondholders usually lend money to the Bond issuers (Govt. or Corporation)
Bondholders, in return, receive their principal amount— the initial investment they made during buying the bond— back when their bonds are matured. Usually, for most of the bonds, the bondholder also receives the periodic interest payments (referred to as Coupon rate)
Investors may also sometimes purchase the bonds directly from the issuing entity.
For example, The Treasury bonds can be bought from the U.S. Treasury during the auctions taking place of the new issues.
Bond investors are also able to purchase previously – issued bonds on the secondary market going through a financial institution or broker.
How Bondholders Earn Income?
Bondholders can earn their income in two primary ways:-
- Most of the bonds return regular interest (coupon rate) payments which are usually paid off semi-annually. But, depending on the structure of the bond it may also sometimes, pay yearly, quarterly, or even as monthly coupons.
For example, if a bond pays a 5% interest rate, called coupon rate, and has a $2,000 face value, the investor will be paid $50 per year or $25 semi-annually until maturity. The bondholder receives their full principal back at bond maturity i.e. when the term is finished ($1,000 x 0.05= $50/2 = $25)
- The other way round for a bondholder to earn an income is through selling the bond in the secondary market which can result in either gain or loss (depending on various factors).
For example, let us assume, an investor paid $5,000 for a bond with a $5,000 face value. If the bondholder tends to sell the bond before it’ s maturity, in the secondary market and assuming, the bond may fetch $5,050, which results in earning $50 on the sale
On the other hand, the bondholder could have a loss, if the bond has a decrease in value from its original purchase price.
Rewards for Bond Holders
Bondholders get regular interest payments and a good return of their invested amount at the time of maturity. Also, sometimes, the interest received is not subject to any taxes. But, there also the risks which they carry along with all the upsides.
Below listed are the Pros and Cons of Bondholders
|Bondholders are able to earn a fixed income along with regular interest rates.||Bondholders are prone to interest rate risk when market rates are rising.|
|Bondholders also have the benefitsof a safe and risk-free investment with U.S. Treasury.||Credit risk and default risk is possible to corporate bonds that are tied to the bond issuer’s financial viability.|
|In the case of the company’ s bankruptcy, bondholders are the ones who receive payment before the common stock shareholders.||Bondholders may also face inflationary risk and if the inflation outpaces the coupon rate of the security they hold.|
|Also, Some municipal bonds assure tax-free interest payments.||When the market’s interest rates outpace the coupon rate, the face value of the bond on the secondary market may also decrease.|
Risk for Bondholders
The interest rate which is paid on a bond might not keep up with the inflation. Inflationary risk is also a measure of the price that increases in the time of an economy.
If the price rise by 5% and the bond pays a 4% coupon, the bondholder has to face a net loss in reality. In other words, the bondholders may have inflation risk.
Bondholders are also made to deal with the potential of interest rate risk. Interest rate risk generally begins when interest rates are rising. Most bonds also have the fixed-rate coupons, and as the market rates rise, they tend to end up paying lower the rates.
As a result, a bondholder may earn generally a lower yield as compared to the market rate in the rate – rising environment.
Becoming a bondholder is usually taken as a low-risk endeavor because the bonds guarantee regular interest payments and the return of amount at its maturity. But, a bond is only as safe as the issuer who is underlying.
Bonds also carry the credit risk and the default risk as they are linked to the issuer’s financial viability. When any company struggles financially, investors are at most risk of the default on the bond.
We hope we are able to clear all the doubts regarding bondholders and if you are planning on being one. Comment down below and start your journey in the investing world.