A bond is a formal contract to repay borrowed money at a later committed date and interest or coupons at fixed committed intervals. Companies issue bonds when the amount required is too large to obtain from a single lender and when approaching the equity market is not a feasible or preferred option. Governments also isue bonds, the US Treasury Bonds being the most common example. The interest payable by the company in the form of coupons beyond the 12-month period and the repayment of the bond capital at the designated date in the future becomes long-term liability.
For example, a bond with a $1,000 maturity value paid in 10 years with 10 percent stated interest paid annually fixes the company’s liability at $100 every year.
The market value of bonds differs from the maturity value, and purchasing the bonds at market value increases or decreases the returns for the investor. The company, however, usually repays only the stated maturity value and interest rate, with changes in market value not changing its liabilities.
Some structured bonds, however, have a maturity value different than the face value. Such bonds link the maturity value to performance of particular assets such as a stock, commodity index, foreign exchange rate, or a fund. Other bonds have floating interest rates, based on reference rates such as LIBOR, or to inflation rates. Such bonds make the long-term liability of the company uncertain, and the balance sheet needs to reflect reserves to cater to expected liability. Equity-linked bonds that peg liabilities on the company’s performance make it easy to set aside liability as a portion of the earnings.
Some bonds have no maturity date. The UK Consols bonds issued in 1888 still trade today, and the West Shore Railroad bonds mature in 2361. The company does not redeem the capital of such perpetual bonds, and does not allocate long-term liabilities. They rather include the continuous payment of coupons or interest rate in current liabilities.