Long-term bonds are investment instruments sold by a large organization or publicly held company. These investments represent a piece of debt sold to an investor. Companies use bonds as an alternate form of external financing outside of equity, which includes stock or direct investments. Purchasing long-term bonds typically provides more security when compared to a company’s stock. Bondholders must receive their investment back at a future time period, including during or after a company liquidates its assets for bankruptcy.
Bonds are often separated into one of two groups: calls and puts. Long-term bonds that are callable means the issuing company can repurchase the investment whenever it desires. Due to the fact that bonds typically have a set maturity date, issuing companies will place a call notice on the investment. This allows the company to “call” the bond and repay the investor when interest rates are lower and the company no longer needs the investor’s funds.
Investors that purchase long-term bonds with a put provision have the ability to demand repayment on the investment at any time prior to the maturity date. The provision allows the investor to receive his money at the most beneficial time to earn profits. Companies may be less willing to issue these bonds, as it can place more strain on their finances as investors have the power to control repayment.
The purpose for these provisions in long-term bonds is that interest rates in a nation’s economy tend to rise over time. Increasing interest rates has a negative effect on the value of a bond. Call and put provision, therefore, allow both companies and investors more control over investment instruments that can exist for one to five years.
Bonds can be a risky investment if they have faulty debt instruments backing them. Since bonds represent a portion of a company’s debt, a business that deals in highly volatile debt instruments, such as subprime mortgages, can result in bonds that carry extreme risk. Both issuing companies and investors can lose their investment if the debt behind the bond investment fails. This occurs because the value of the bond goes to zero, as the company cannot repay the value of an investment that does not exist.
Government municipalities can also issue long-term bonds. These typically occur at the local and state level within the government. Government bonds are usually more secure than a company’s bonds, although the maturity time can be longer. These investments help municipalities pay for major infrastructure improvements; therefore, the bonds do not typically have call or put options. Investors can only receive payment when the municipality repays the loan at maturity.