The second type of debt financing is corporate debt or bonds. A bond is a security sold to an investor. It is a contractual obligation between the issuer and the holder. The issuer promises to make interest payments to the holder at specific dates and to return the principal at a certain date (maturity). Bonds must be registered with the Securities and Exchange Commission (SEC). One other difference between a loan and a bond is that typically a loan is considered a claim on an asset and a bond is a claim on a specified stream of income.
The amount of the bond to be paid at maturity is called the bond's face value. The rate of interest to be paid by the issuer is called the coupon rate. You may wonder why the coupon rate is important. The answer lies in the fact that the duration of a bond is usually for a period of 10 to 30 years. Interest rates can vary with the market. If the coupon rate of a bond is 5 percent and the current interest rates are expected to be 10 percent, then that bond will sell at a discount.
When a bond is sold at a discount, it costs less than its face value. It would have to sell at less than its face value in order to compensate for the coupon rate of 5 percent versus a market of 10 percent. Be mindful that the issuer has to pay the face value at maturity. In the case where the coupon rate is 5 percent and the market is demanding 2 percent, the bond would trade for an amount greater than its face value. The amount over and above face value ...