Bonds and loans are similar to one another in that they perform a similar function by lending money for which interest is charged. While the interest on loans can be fixed or variable, the interests on bonds are usually fixed. Bonds and loan operate in quite the same manner; however, there are a number of important differences between the two. The article offers a clear explanation on bonds and loans and shows how bonds and loans are similar and different to one another.
Bond
Bonds are debt instruments, and when an investor purchases a bond they are effectively loaning money to the government or to a company (depending on the type of bond purchased). The entity that issues bonds will be borrowing funds for a fixed period of time by paying a fixed rate of interest to the bondholder. As the interest that is received by the bondholder is fixed in nature, bonds are usually referred to as fixed income securities.
Bonds are used by a number of parties including corporations, states, municipalities, etc. and are used to fund business operations, investments, projects and other activities. The interest rate paid on a bond is called a coupon interest and the amount that is borrowed is referred to as the bond principal. The duration of the bond will be completed once it reaches its maturity date at which time the coupon interest payments and the principal value of the bond will be fully paid to the bondholder. Bonds pay coupon interest annually and semi-annually.
Loan
A loan is when one party (called the lender, which is usually a bank or financial institution) agrees to give another party (called the borrower) a sum of money that is to be paid back after a certain period of time. The lender will charge the borrower an interest on the money that has been lent and will expect the interest payments to be made on a periodic (usually monthly) basis. At the end of the loan term, the full repayment of the principal and interest should be made. The terms of the loan should be set out in a loan contract which lays out the terms for repayment, interest rates and deadlines for payment.
Loans are taken out for a number of reasons such as to purchase vehicles, to pay college tuition, mortgages to purchase housing, personal loans, etc. Lenders such as banks and financial institutions usually test the borrower’s credibility before lending funds. There are a number of criteria that should be met by the borrower; which include credit history, salary/income, assets, etc.
What is the difference between Bond and Loan?
Bonds and loans are quite similar to one another in that they both offer loans to borrowers for which interest is charged. Bonds and loans operate in quite the same manner where the borrower will borrow funds from the lender either by taking out a loan or purchasing a bond and the borrower will pay periodic interest over the period of the bond term/loan term. Once the bond or loan reaches maturity the borrower will repay the total principal amount alongside any other interest payments due. Despite these similarities, there are a few differences between the two. The main difference is that with loans the bank and other financial institutions are the lenders and individuals or corporations are the borrowers. However, with bonds the general public is the lenders and corporations and governments are borrowers. Loans can be obtained by anyone who has the capacity to repay the loan; however, bonds can only be issued by larger corporations or government entities. Another major difference between the two is that bonds can be traded, and the lender can retrieve their funds before maturity, if necessary. Loans do not have a market in which they are traded. However, with the recent advancements in securitization lenders such as banks can now sell off the loan to third parties such as other financial institutions.
Summary:
Bond vs Loan
• Bonds and loans are quite similar to one another in that they both offer loans to borrowers for which interest is charged.
• Bonds are debt instruments, and when an investor purchases a bond they are effectively loaning money to the government or to a company.
• A loan is when one party (called the lender, which is usually a bank or financial institution) agrees to give another party (called the borrower) a sum of money that is to be paid back after a certain period of time.
• With loans, the bank and other financial institutions are the lenders and individuals or corporations are the borrowers, whereas the general public is the lenders and corporations and governments are borrowers in the case of bonds.
• The bonds can be traded, and the lender can retrieve their funds before maturity, if necessary. Loans do not have a market in which they are traded.
• However, with the recent advancements in securitization lenders such as banks can now sell off the loan to third parties such as other financial institutions.