in this video I want to give you a
general idea of what a bond is and why a
company might even issue them in the
first place and just at a very high
level a bond is essentially a way for
someone to participate in lending to a
company so you're a partial lender
partial lender to a company and just to
make that more concrete let's imagine
some type of company that has ten
million dollars in assets so these are
its assets right they're assets and it
has ten million dollars in assets and
let's say just for the sake of
simplicity it has no liabilities so all
of that value all of that ten million
dollars is what is owned by the owners
or by the equity the owner's equity so
this is ten million dollars ten million
dollars in equity and if we had let's
say a million shares I'll write it down
if we have a million shares and if we
believe this ten million dollar number
that implies that each share is worth
$10 per share now let's say this company
is doing really well and it wants to
expand it wants to increase its assets
by five million dollars so it can go out
and buy a five million dollar factory so
it once let me draw it right here it
wants another five million dollars in
assets that it needs to build that
factor or essentially a five million
dollar factory and the question is how
does it finance it well one way is that
they could just issue more equity if
they're able to get a price of $10 per
share they could issue another 500,000
shares 500,000 shares at $10 per share
and then that would essentially it
produce five million dollars so this is
scenario one they issue 500,000 shares
at $10 a share
they now have 1.5 million shares but
these new owners gave them collectively
5 million dollars so this the equity
would grow by 5 million dollars we now
have 1.5 million shares
so this would
I'll be 1.5 million shares not 1 million
and that new money from these new
shareholders would go into the asset
side and then we would use that to
actually buy the factory what I just
described is essentially issuing equity
or financing via equity financing via
equity or by issuing stock now the other
way to do it is to borrow the money to
borrow the money so let me redraw this
company I'll leave this up here just so
we can compare the two so once again we
have 10 million dollars of assets that's
our 10 million dollars of assets we have
10 million dollars of equity to start
off with 10 million dollars of equity
and instead of issuing stock to get the
five million dollars we're going to
borrow the money so we could we're
essentially issuing debt so we issued we
essentially we could go to a bank and
say hey bank can I borrow five million
dollars so we would have a five million
dollar in liability it would be debt
five million dollars of debt and the
bank would give us five million dollars
of cash that we can then go use to buy
our factory so in either situation in
either situation the asset side of our
balance sheet looks at identical or the
assets of the company identical we had
our ten million dollars assets and now
we have a factory but in this first
situation I increased I was able to
raise that money by increasing the
number of shareholders by increasing the
number of people that I have to split
the profits of these of this of this
company with in this situation I was
able to raise the money by borrowing it
so these the people that I'm borrowing
this money from the people that I'm
borrowing this money this is borrowed
money borrowed money they don't get a
cut of the profits of this company what
they do is they get paid interest on
their money that they're lending to us
before these guys get any profits at all
in fact that interest is considered an
expense so these guys get interest get
interest and even if this company does
super
super well and becomes very very
profitable these guys only get their
interest likewise if the company does
really bad and these guys suffer as long
as the company doesn't go bankrupt these
guys are still going to get their
interest so they're going to be a lot
safer than well they don't get as much
of the reward as the new equity holders
would they also don't get as much of the
risk now this is just straight up debt
and you could just get this from any
bank if they were willing to if they
said oh you know you're a good safe
company we're willing to lend you five
million dollars but let's say that no
bank wants to individually take on that
risk so you say hey why don't instead of
borrowing five million dollars from one
entity why don't I buy it borrow it from
five thousand entities so what I can do
instead instead of borrowing it from one
empty I could issue these certificates I
could issue bonds and that's the topic
of this video so I issue these
certificates they have a face value of
$1,000 $1,000 this is my face value face
value or sometimes you'll hear the the
notion of par value of par value and
I'll say what interest I'm going to pay
on it so let's say I say it has a 10%
annual coupon annual coupon and it's
actually called even though this is the
interest I'm essentially going to pay
$100 a year it's called a coupon because
when they when bonds were first issued
they would actually throw these little
coupons on the bond itself and the owner
of the certificate could rip off or cut
off one of these coupons and then go to
the person borrowing or the entity
borrowing the money and get their actual
interest payment so that's why it's
actually called coupons but they don't
actually attach those coupons anymore
and it has some maturity date the date
that not only will I pay your interest
back but I'll pay the entire principal
the entire face value so let's say the
maturity maturity is in two years is in
two years so in this situation in order
to raise five million dollars I'm going
to have to issue five thousand of these
because five thousand times 1000 is five
million so times
five thousand so if you wanted to lend a
thousand dollars to this company so that
they could expand and if you think 10%
is a good interest rate and it's a safe
company you would essentially buy one of
these bonds maybe you buy it for $1000
and when you buy that bond for $1,000
you are essentially lending this company
that $1000 and if you did that five
thousand times or if that happened five
thousand times amongst a bunch of
different people this company would be
able to raise its five million dollars
now just to be clear how the actual
payments work the coupons tend to get
paid semi-annually so let me draw a
little timeline here and this tends to
be the case in the US and Western Europe
if this is today this is today this is
in six months this is in twelve months
or one year this is in eighteen months
and this is in 24 months and I'm only
going up to 24 months because I said
this bond matures in 24 months so what
is this if you own if you hold this bond
this certificate what do you get well
it's going to pay you 10% annually so a
hundred dollars a year a hundred dollars
per year but they actually pay the
coupon semi-annually so you get 100
dollars a year but you get half of it
every six months so you're going to get
50 dollars after six months you're going
to get fifty dollars after twelve months
or after another six months you're going
to get another $50 here you're going to
get a final $50 there and they're also
going to have to pay you back the
original amount of the loan they're also
going to have to pay you the $1,000 so
that last payments going to be the
coupon of 50 plus the thousand dollars
and so you will have essentially been
getting this 10 percent annual interest
now when the company does this they'll
probably have to issue some type of new
bond because all of a sudden they have
to pay all of these people this huge
lump sum of money if they haven't been
able to earn it from the factory as yet
and we could talk about that in a future
video