Personal Finance & Money Stack Exchange is a question and answer site for people who want to be financially literate. It only takes a minute to sign up.
Sign up to join this community
Bank loans have options to repay the principal and interest over the time. Correct me if I'm wrong, but AFAIK, bonds don't have these options but to repay the principal all at once.
And this certainly become a burden to companies at the maturity date. This is a risky characteristic of bonds. Are there any reasons to prevent to repay the principal and interest over the time? And if there are options already, why companies are not using the options?
Many companies never intend to reduce their debt to zero. Instead, they roll over their debt:
Rather than paying off the principle of a debt when it comes due, you take out another loan for that amount to pay off the first debt. This will often be the same lender you owe the money to. The terms may change (due date, interest rate) and could be better or worse for the borrower depending on the interest rate environment (and of course his credit rating).
So to answer your question directly, these companies do not pay both principal and interest periodically because they aren't trying to reduce their debt. Instead they expect to roll it over.
Moreover, recall that the enterprise value of a business is the sum of its market capitalization and its debt. From this perspective, a business is thought of as being owned by both equity-holders and debt-holders. Assuming the business is successful, the debt holders expect periodic payments of interest and get paid first out of profits. The remaining profit is owned by the equity holders. Thus, these two classes -- the equity holders and the debt holders -- together "own" the enterprise. These kinds of businesses generally do not seek to remove the debt holders from the business. The debt-to-equity ratio may bounce around, but generally never falls to zero because the debt is rolled over.
As long as the business remains sucessful, there is generally never a lack of investors willing to buy debt. The main issue is the interest rate, not the availability of credit.
Businesses deploy the capital raised by debt issuances to fund projects and build the business. They do so with the belief that for every dollar they deploy they can generate cash flow of more than a dollar. If they were to use some of that cash flow to pay off principal, then they would have fewer dollars to deploy funding projects and building the business. If they believe their rate of return is greater than their cost of capital, they should prefer to spend their dollars investing in projects instead of not paying off debt.
PS. There are such things as sinkable bonds which are
backed by a fund that sets aside money to ensure principal and interest payments are made by the issuer as promised.
Sinkable bonds are used to attract investors who may otherwise find the business's creditworthiness too risky.
The main issue is the interest rate, not the availability of credit... I'm thinking about the Greece economic crisis(Link). According to the video in the link, Greece failed to roll over their debt due to 2008 collapse, causing the crisis. So, I thought availability of credit is also very important. Greece was enjoying low-interest rate too.
Jun 12, 2018 at 2:38
When I buy a bond I don't want the company to have the option of repaying the principal early. That's because they would do it at a time when it's to their benefit, typically because interest rates have gone down and they can borrow money more cheaply. But that means I lose the benefit of the higher interest rate that my bond carries, and I would have to reinvest the bond principal in a lower-yielding security.
That's why I don't buy callable bonds, which are bonds that the issuer can pay off early under certain specific conditions.
1) Corporates want to sell bonds. Using non-standard practices such as an amortising repayment schedule is not generally attractive to investors.
2) Corporates have funding profiles: averaged over all of their bonds they have a series of principal outflows which are well dispersed. Consider 1Y, 2Y, 3Y, 4Y, 5Y bonds in 100m each, as opposed to a single 5Y bond in 500m. This actually synthesises the structure of your question.
3) Options to repay early create callable bond. The embedded option is a cost to the corporate and a nuisance to risk manage, so why bother?
bonds don't have these options but to repay the principal all at once.
Corporate Bonds are products meant to tap individual investor / Financial institution having excess money that they would otherwise park in Bank Deposits [depending on geography terms used like Fixed Deposits or Certificate Deposit or Time Deposits]. As these products from Bank offer low rates, it makes it attractive to invest in Bonds that give better rate.
The investors expect a steady income of interest for their needs.
Unlike Bank Deposits that can be encahsed premature; Corporate Bonds had a limitation. This [and other reasons] there are now mutual funds that invest in Bonds and individual investor can purchase the Mutual Fund.
Thus there maybe very little market for Corporate Bonds that pay back the principal.
From a Corporate point of view, this adds to cash flow issues at the time of Bond maturity; however they get access to cheap funds [compared to loans from Banks] and have time to plan for the redemption. They either have sufficient cash to pay it off; or issue new Bonds or take a loan from Bank.
