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Why Do Corporations Issue Bonds?

Corporations issue bonds for several reasons: 
  1. Provides corporations with a way to raise capital without diluting the current shareholders' equity. 
  2. With bonds, corporations can often borrow at a lower interest rate than the rate available in banks. By issuing bonds directly to the investors, corporations can eliminate the banks as "middlemen" in the transactions. Without the intermediaries, the borrowing process becomjes more efficient and less expensive. 
  3. By issuing bonds, corporations can often borrow money for a fixed rate for a longer term than it could at a bank. Most banks will not make fixed rate loans for longer than five years because they fear losing money if their cost of funds (raised by selling CDs, savings accounts, and the like) rises to a higher rate than long-term loans. Most companies want to borrow money for long terms and so elect to issue bonds. 
  4. The bond market offers a very efficient way to borrow capital. By issuing bonds, the borrower is spared the task of undergoing numerous separate negotiations and transactions in order to raise the capital it needs. 
Instead, when corporation issues bonds, creates one master loan agreement and offers investors a chance to participate in the loan. The company offers the identical deal to all investors regardless of whether the individuals interested in buying just one bond each or corporations buying 1000 bonds. The master loan agreement between the corporation and the investors is called a bond indenture. The indenture contains information that you would expect in any loan agreement such as: 
  •  The amount of money the company is borrowing. 
  • The interest rate the company will pay. 
  • The collateral for the loan (if any). 
  • When the company will make its interest payments. 
  • Whether the company will pay off the loan, that is, when the bonds will mature. 
  • Whether the company and/or the investors will ahve the choice of shortening the bond's original maturity. 

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This page is created by Julia Lee '99 and is maintained by Professor Satyananda Gabriel of the Economics Department, Mount Holyoke College, January 1999.