Whether it is for personal, business or governmental needs finance plays an important role in the world economy. Without proper financing, major personal, business, and governmental projects cannot be completed.
There are two major ways a person, business, and government around the world can raise capital. These are loans and bonds. Through these monetary processes, the lender gives money to the borrower with some terms and conditions. The primary term and condition for all cases are that the borrower will return the money with agreed-upon interest.
The process benefits both parties. As the borrower gets finance for his project, the lender also gets an opportunity to earn from his capital. Due to this similarity, many people believe that the loan and the bond is the same thing.
Loan vs Bond
The main difference between Loan and Bond is that a loan finance raising procedure is for individuals and small business entities; whereas the bond is a capital-raising procedure for government, municipal, agencies, and corporate entities.
Comparison Table Between Loan and Bond (in Tabular Form)
| Parameter of Comparison | Loan | Bond |
|---|---|---|
| Issuer | Financial institutions like banks. | Governments, municipal, agencies, and corporate entities. |
| Duration | Short, medium, and long term | Mostly for the long term. |
| Tradability | No, loans are not tradable in any market. | Yes, on the bond market and over the counter. |
| Interest rate | Fixed or variable | Low-interest rate |
| Examples | Mortgage loans, car loans, credit card loans, etc. | Treasury bonds, zero-coupon bond, corporate bonds, etc. |
What is Loan?
A loan is a debt instrument by which an individual, business entities, and government get capital from a financial institution. The money is given by the financial institution comes with the term of repayment. The borrower repays the loan with the principal amount and agreed-upon interest.
There are two types of loans, secured loans & unsecured loans. The financial institution or bank gives a secured loan in exchange for collateral, where the lender poses the right to acquire the collateral if the borrower fails to repay the money. Mortgages and car loans are prime examples of a secured loan.
The unsecured loan is given on the reputation of the borrower and it is not supported by any collateral. Signature loans and credit card loans are prime examples of unsecured loans.
Interest rates for secured loans are low, but the interest rates for unsecured loans are high. The interest can also vary on the market conditions. There are many secured loans offered to the borrower with fixed-rate (where the interest rates remain constant throughout the lending period), or it might be a flexible rate (where the interest rate changes upon the market condition).
Depending upon the conditions of the loan the borrower repays the amount of loan in installment or revolving term.
What is Bond?
A bond is a capital-raising tool by which governments and corporate business entities can gather investment from the financial market. Most bonds can be referred to as an I.O.U. The borrower makes promises to return the money with matured interest on fixed tenure.
The benefit of a bond is that it is tradable in the bond market and on over counter. Here the lender does not have to wait for the fixed tenure to get back the money. It can be enchased before its maturity date.
Bonds can be segmented in four prime categories. These are government bonds, municipal bonds, agency bonds, and corporate bonds. Depending upon the interest or coupon payment bonds can be classified in different categories. These are zero-coupon bonds, convertible bonds, callable bonds, and puttable bonds.
The inverse to interest rates of a bond depends on the risk of return. A bond with a high risk of return yields more inverse to interest rates. As an example, a government bond where the chances of payment are higher valued less. On the other hand, a corporate bond where the return of capital is risky valued high.
Main Differences Between Loan and Bond
- The primary difference between the loan and bond is the issuer. Most loans around the world are issued by financial institutions like banks. Where, most bonds around the world issued by the government, municipals, agencies, and corporate companies.
- There can be various duration to repay the loans. It can be short, medium, and long term loans. However, most of the duration of bonds is for the long term.
- Loans are not tradable in the market, but bonds are. Most bonds get traded in the bond market, where their price fluctuates every day.
- There are two types of loans, secured loans & unsecured loans. The secured loans are backed by the collateral of the borrower, and the unsecured loans are backed by nothing but the reputation of the borrower. Where, there can be various types of bonds like zero-coupon bonds, convertible bonds, callable bonds, and puttable bonds.
- Interest rates on most loans are fixed or flexible, with the fixed interest rate the borrower has to pay the agreed-upon interest rate for the full duration of the loan. The flexible interest rate changes upon the market condition. However, the interest rates on most bonds are low and they are considered as the safest investment.
Conclusion
Loans and bonds are both efficient monetary systems to raise capital. Most individual and small business entities take loans for their financial needs, where most governments and large business corporations around the world sell bonds to raise capital for various projects.
This monetary mechanism makes many things possible both for individuals and countries. For the individual, financial support helps individuals purchase a new house, car, or consumer goods. For businesses, it helps them expand their operations; and for the government, the monitory support helps them make policies for the public.
Both loans and bonds are run on trust. The lenders believe that they will make additional income after a certain period. Even with all uncertainty of the world, the default rate for both loans and bonds is very small. Both of these mechanisms are functioning for years, and day by day the world is gaining prosperity thanks to various loans and bonds.
References
- https://www.econstor.eu/bitstream/10419/45273/1/656652209.pdf
- https://dspace.tul.cz/bitstream/handle/15240/30584/242.pdf?sequence=1&isAllowed=y