What is a Bond?
When someone mentions Wall Street most people think of stocks and bonds. Stocks represent equity, or outright ownership. Bonds, in contrast, represent debt, or a loan. An investor who buys bonds of a corporation or government unit simply lends it money, and no ownership is involved. Corporations needing to raise money have a choice: they can either issue stock, thereby increasing their equity, or they can issue bonds, increasing their debt. However, since governments don't issue stock, when they need money they come to the bond market.
Bonds are the main form of a somewhat broader category called fixed income securities, other forms of which include bank certificates of deposit, preferred stock and commercial paper. Unlike equity investments, the rates of return on fixed income securities are set at issuance and remain unchanged and enforceable by law.
Bonds and other fixed income securities are issued and traded in three separate markets--US Treasury, corporate, and municipal. In many ways, the US Treasury bond market comes first. The federal government is our biggest single borrower, and its bond issues promote national, rather than regional or private, interests. Backed by the full faith and credit of the nation, they are considered our strongest bonds. Most of our major corporations also borrow by issuing corporate bonds. Who are the municipal borrowers? State and local governmental units, such as the State of Michigan or Westchester County, New York or Sandy School District, Utah.
We mentioned that investors can choose either equity (stock market) or debt investments (bond investments). The usual way to invest in equity is to buy common stock, each share representing the outright ownership of one fraction of a corporation.
Investors put their money into debt securities by buying bonds and similar obligations of the Federal Government, of corporations, or of municipalities. What exactly are bonds? They represent a contract between borrower and lender which specifies the sources of money pledged to repayment, the rate of interest, the rights of bond holders, and the date the debt will be repaid. This contract is the legal bond between issuer and investor, fixing their relationship until the debt is redeemed.
To repeat, bond investors do not, like stockholders, own a part of the issuing body itself; they are simply its creditors. (Wilson White)