What are two distinct obligations incurred by corporations when issuing bonds?
The corporations must pay the interest promised and pay the investors the full value of the bonds when they come due.
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When a corporation issues bonds, it incurs two distinct obligations:
1. Interest Payments: One obligation is to make regular interest payments to bondholders. Bonds have a stated interest rate, which is the percentage of the bond's face value that the corporation agrees to pay as interest. These interest payments are typically made semi-annually or annually, depending on the terms of the bond. The corporation must make these payments on time to fulfill its obligation to bondholders.
To determine the interest payment amount, you need to know the face value of the bond, the interest rate, and the frequency of interest payments. Multiply the face value by the interest rate to calculate the annual interest payment, and then divide it by the number of interest payment periods in a year. For example, if a $1,000 bond has a 5% interest rate and pays interest annually, the calculation would be: $1,000 x 0.05 = $50. So, the corporation would need to make a $50 interest payment once a year.
2. Principal Repayment: The other obligation is to repay the principal amount of the bond when it reaches maturity. The principal, also known as the face value or par value, is the amount stated on the bond, which the corporation must repay to the bondholders at maturity. Maturity is the date when the bond expires, typically several years after issuance. It represents the end of the bond's term and the final repayment to bondholders.
To calculate the principal repayment at maturity, you simply need to know the face value of the bond. For example, if a bond has a face value of $1,000, the corporation would need to repay $1,000 to bondholders when the bond matures.
By fulfilling these two obligations, corporations maintain their financial integrity and ensure the trust of bondholders, which is essential for future fundraising activities.