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This chapter described the different types of bonds governments and corporations issue, explained how bond prices are established, and discussed how investors estimate the rates of return they can expect to earn. We also discussed the various types of risks that investors face when they buy bonds.

It is important to remember that when an investor purchases a company’s bonds, that investor is providing the company with capital. Therefore, when a firm issues bonds, the return that investors receive represents the cost of debt financing for the issuing company. This point is emphasized in Chapter 6, where the ideas developed in this chapter are used to help determine a company’s overall cost of capital, which is a basic component in the capital budgeting process.

The key concepts covered are summarized below.

• A bond is a long-term promissory note issued by a business or governmental unit. The issuer receives money in exchange for promising to make interest payments and to repay the principal on a specified future date.
• Some recent innovations in long-term financing include zero coupon bonds, which pay no annual interest but that are issued at a discount; floating rate debt, whose interest payments fluctuate with changes in the general level of interest rates; and junk bonds, which are high-risk, high-yield instruments issued by firms that use a great deal of financial leverage.
• A call provision gives the issuing corporation the right to redeem the bonds prior to maturity under specified terms, usually at a price greater than the maturity value (the difference is a call premium). A firm will typically call a bond if interest rates fall substantially below the coupon rate.
• A redeemable bond gives the investor the right to sell the bond back to the issuing company at a previously specified price. This is a useful feature (for investors) if interest rates rise or if the company engages in unanticipated risky activities.
• A sinking fund is a provision that requires the corporation to retire a portion of the bond issue each year. The purpose of the sinking fund is to provide for the orderly retirement of the issue. A sinking fund typically requires no call premium.

Taken From : Five-Minute MBA – Corporate Finance

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