Introduction to bonds | Stocks and bonds | Finance & Capital Markets | Khan Academy

In this video, I would like to outline the essence of bonds and above all why the company could publish them at all. First of all. And at a very high level is a bond basically a way to participate in the provision of loans to the company so you become a partial creditor, partial creditor, given companies, if we take a specific example, imagine the type of company which has $ 10 million in total assets so this is their property fortune, and has 10 million total assets Simply put, let's say that the company has no liabilities, that is, the whole value, as much as $ 10 million is owned by business owners or capital, the equity of the owners so that's $ 10 million capital $ 10 million. And if we had, say, a million shares I'll write it down. When we have a million shares, and we're considering a full $ 10 million, then each share is worth $ 10 per share. We now believe that the company is doing very well and wants to expand. He wants to increase the value of his assets by $ 5 million to buy a $ 5 million factory for them, so he wants…, I'll draw it.

The company wants another $ 5 million in total assets, which he needs to build a factory, or basically a $ 5 million factory. The question is how to finance it? One way is to spend more capital. If they can raise $ 10 a share, may issue an additional 500,000 shares, 500,000 shares at $ 10 per share, which in the end will bring in $ 5 million. This is the first scenario. The company will issue 500,000 shares for ten dollars. They now have 1.5 million shares, but the new owners put them together $ 5 million equity thus increased by $ 5 million. So now we have 1.5 million shares, and we acquire 1.5 million shares, instead of one million, this money from new shareholders we add to the property side and then we use them to buy a factory. What I have just described is basically the issuance of capital or equity financing.

Equity financing, or a capital increase by issuing shares. The second way a company can achieve this is is to borrow money, borrow money, I will redraw our society here again so that we can compare the two options. Once again, we have $ 10 million in assets. This is the 10 million. So we start with a capital of $ 10 million, we have a capital of 10 million, but instead of issuing shares to raise five million dollars the company borrows money we can say that we issue debt so we issue we could come to the bank and say "Bank, can I borrow $ 5 million?" So we could have a 5 million commitment, it would be a debt. $ 5 million debt and the bank would give us $ 5 million in banknotes, so we can go and use them to buy a factory. In both cases…. in both cases the company's assets remain identical respectively the company's assets are identical. We have our $ 10 million in assets, and now we have a factory, but in the first case, I was able to increase the amount of money by increasing the number of shareholders increasing the number of people between which I have to divide the company's profits.

But in the second situation, I was able to increase the amount of money by borrowing them. And the people from whom I borrow money those from whom I borrow money, … this is borrowed money, … borrowed money. These people do not share in the company's profits. What they receive is interest paid for loan intermediation, before any of their real profits. In fact, we consider this interest to be an expense, so these people get interest … they receive interest … And even though the company is doing very, very well, and becomes very profitable, these people still receive only the given interest. Similarly, when a company fails and it bothers me, it is true that until the company goes bankrupt, these people will continue to receive their interest, so it is a much safer option for them, although they don't get that much money as if the new shareholders had.

At the same time, they do not run into such a risk. This can be considered a debt, and you can borrow it from any bank, if she is willing. When they say, "You're a good, secure company." "We're willing to lend you $ 5 million." But let's say no bank he does not want to take such a risk So you say, "Why not borrow $ 5 million instead of one entity." "Why not borrow from 5,000 entities instead? Why can't I do that … to replace a loan from a single entity. I could issue securities, issue bonds. That is the subject of this video.

So I issue securities. Their nominal value is $ 1,000. Nominal value, or sometimes you will hear the nominal value nominal values. and I'll say what interest I'll pay it off, let's say it has a 10% annual coupon, annual coupon, … and it's called that because even though it's interest, I simply pay $ 100 dollars a year. It's called a coupon because when, when the coupons were first issued, they added these coupons to the bond itself, and the owner of this certificate could remove them or cut off one coupon, and then go to the debtor, or the entity that borrowed the money and get their share of the payment. That's why it's called a "coupon", although they are no longer added to the debt. And it also has its maturity, the date on which I will not only pay interest, but I will pay the whole debt, full face value, let's say that the maturity, maturity is up to two years, up to two years, in this situation, to increase the stock by $ 5 million, I will have to release 5,000 of them because 5,000 times 1,000 is 5 million, so times 5,000.

So if you would like to borrow $ 1,000 from this company so they can expand and if you think 10% is good interest, and if it is a secure society you would simply buy one of these bonds. Maybe you can buy it for $ 1,000, and once you buy that bond for $ 1,000, so you basically lend to this company those $ 1,000, and if you've done that 5,000 times, or if it happened 5,000 times, among many different people this company would be able to increase the status quo about $ 5 million. To be clear about how this payment works. These coupons are usually repaid year-on-year, let me draw a timeline here, and this is often the case in the US and in Western Europe.

If this is today. This is today. This is in 6 months. This is in 12 months or 1 year. This is in 18 months, and this is in 24 months, and we'll end up in 24 months. because I said that the maturity of this bond is 24 months. So what does that mean if you own, you hold this bond, this certificate, what do you get? It pays you 10% a year, so $ 100 a year. $ 100 per year. However, these coupons are valid between-yearly, so you get $ 100 a year but every 6 months you get half of so you get $ 50 after 6 months. You will get another $ 50 after 12 months, or simply for another 6 months. You will get another $ 50 here. You get the last $ 50 here, and they will also have to pay you the original price of the loan. They'll also have to pay you $ 1,000, so the last fee will be a coupon worth 50 plus the $ 1,000 therefore you gained this 10% annual interest.

Now that society has done this, so they usually issue a different type of bond because out of nowhere they have to pay all these people this huge amount of money and if they didn't earn it so far from their factories, and we could talk about this in a future video..

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