Bonds


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Related to Bonds: Savings Bonds, Treasury bonds, Premium bonds, investment bonds, Government bonds

Bonds

Written documents by which a government, corporation, or individual—the obligor—promises to perform a certain act, usually the payment of a definite sum of money, to another—the obligee—on a certain date.

In most cases, a bond is issued by a public or private entity to an investor who, by purchasing the bond, lends the issuer money. Governments and corporations issue bonds to investors in order to raise capital. Each bond has a par value, or face value, and is issued at a fixed or variable interest rate; however, bonds often can be purchased for less or more than their par value. This means that the yield, or total return on a bond, varies based on the price the investor pays for the bond and its interest rate. Generally, the more secure a bond is (i.e., the stronger the assurance that the bond will be paid in full upon maturity), the less the bond will yield to the investor. Bonds that are not very secure investments tend to have higher returns. Junk bonds, for example, are high-risk, high-yield bonds. Except for the high-risk variety, bonds tend to be relatively solid, predictable investments, with prices that vary less than those of those of stocks on the Stock Market. As a result, litigation because of unpaid bond agreements has rarely proved necessary.

The most common type of bond is the simple bond. This bond is sold with a fixed interest rate and is then redeemed at a set time. Several varieties of simple bonds exist. Municipal governments issue simple bonds to pay for public projects such as schools, highways, or stadiums. The U.S. Treasury issues simple bonds to finance federal activities. Foreign governments issue simple bonds, known as Yankee bonds, to U.S. investors. Corporations issue simple bonds to raise capital for modernization, expansion, and operating expenses.

Conditional bonds do not involve capital loans. Most of these bonds are obtained from persons or corporations that promise to pay, should they become liable. The payment is usually a nonrefundable fee or a percentage of the face value of the bond. A bail bond is a common type of conditional bond. The person who posts a bail bond promises to pay the court a particular sum if the accused person fails to return to court for further proceedings on the date specified. Once a bond payer satisfies the terms of a conditional bond, the liability is discharged. If the bond goes into default (i.e., if the obligations specified are not met) the amount becomes immediately due. Parties also can mutually decide to cancel a conditional bond.

The emergence of simple government and corporate bonds into the modern marketplace began with the economic boom of the 1920s.

Michael R. Milken: Genius, Villain, or Scapegoat?

Few business personalities have attracted as much attention—both negative and positive—as bond market financier Michael R. Milken. After earning an estimated $1.1 billion in the 1980s as the head of Drexel Burnham Lambert's Securities branch, Milken fell from grace in the press and in the eyes of many investors. In 1990 the Securities Exchange Commission charged Milken with securities Fraud. In U.S. district court, Milken was fined $600 million, permanently barred from engaging in the securities business, and sentenced to ten years behind bars. Some of Milken's associates believed that he had been made a scapegoat; Milken's prosecution, they argued, was little more than an attempt to pass judgment on the 1980s, sometimes cast as the decade of greed.

Milken had formerly been heralded by the Wall Street Journalas one of the century's most important financial thinkers. In the 1970s, after finishing studies at the University of Pennsylvania's Wharton Business School, Milken was early in anticipating the boom of the Junk Bond market. He used his understanding of trends in investment activity, along with innovative approaches, to capitalize on what he called high-reward bonds. The junk bond boom led to both Milken's ascent and his incrimination. Milken's correct assessment of the junk bond boom paid off for him. While he worked for the powerful Drexel Burnham Lambert firm, his profits made him a billionaire. But how he made those profits also led to his downfall. The government held evidence implicating Milken in manipulation of stocks, insider trading, and Bribery of investment managers.

With fines and damages in civil lawsuits totaling $1 billion, Milken became one of several news-making, white-collar criminals of the 1980s. After his sentencing, the Wall Street Journalretracted its praise of the man, saying that "evidence now suggests that Mr. Milken's theory was wrong—and that he was far from the genius he seemed to be about junk bonds." (National Review, August 31, 1992). Milken's theory held that the high yields of junk bonds would draw investors to purchase many of them and that defaults on these securities would be few. The intense corporate competition of the 1980s waned; however, and in later years, investors moved away from junk bonds in search of other investment opportunities. Following his release from prison, after serving two years of his ten-year sentence, Milken was invited to lecture on ethics in business at the University of California, Los Angeles. To critics, however, Milken remained an icon of the money-mad 1980s, a financial wizard driven by the promise of vast wealth to push the limits of securities law. The one-time billionaire reemerged from prison with $300 million from his days as the king of junk bonds, which he used entrepreneurially in the education market, most notably as the brainchild behind Knowledge Universe, a company that owned several other education training and consulting companies, including the popular Leapfrog Enterprises (makers of LeapPad learning aids). Additionally, Milken became more visible in his philanthropic endeavors, particularly favoring prostate cancer research and Milken creations such as the Milken Family Foundation, the Milken Institute, and Mike's Math Club.

Further readings

Bailey, Fenton. 1992. Fall from Grace: The Untold Story of Michael Milken. Secaucus, N.J.: Carol Pub. Group.

Fischel, Daniel R. 1995. Payback: The Conspiracy to Destroy Michael Milken and His Financial Revolution. New York: HarperBusiness.

Platt, Harlan D. 2002. The First Junk Bond: A Story of Corporate Boom and Bust.Washington, D.C.: Beard.

Cross-references

Investment; Stock; Stock Market.

Immediately after World War I, the U.S. economy rewarded investors who were eager to see expansions in industrial growth. For most of the 1920s, until just before the Great Depression, interest rates remained low. The bond market became sophisticated enough to raise funds for the U.S. Treasury, domestic corporations, and foreign borrowers. It also proved useful during World War II, when the federal government depended on the sale of war bonds to finance its military efforts.

During the 1980s, a different kind of boom in the U.S. economy sent the bond market in a more problematic direction. Even though high-yielding bonds tend to be less reliable investments than low-yielding ones, the rapidly increasing business activity in the 1980s led to large-scale buying of these high-risk investments. Corporations successfully bought out the stock of other corporations by raising money through the sale of millions of dollars of junk bonds. (Junk bonds have been given low ratings when measured by standard investment criteria—hence the pejorative name.)

Troubles soon arose from the shaky foundation of the Junk Bond market. One of the country's leading figures in fostering junk bond investments, Michael R. Milken, faced criminal charges that he had manipulated bond prices, traded on inside information, and bribed investment managers. Milken's image was further complicated by his having worked with the stock baron Ivan F. Boesky, who had been convicted of insider trading. In April 1990, in Securities & Exchange Commission v. Milken, 1990 WL 455346, Fed. Sec. L. Rep. ¶ 95,200 (S.D.N.Y. April 24, 1990), Milken pleaded guilty to six felonies, including conspiracy, securities fraud, and aiding and abetting the filing of a false document with the Securities and Exchange Commission. At the time of the initial settlement, Milken agreed to pay $600 million in fines and reparations. In November 1990, federal judge Kimba M. Wood sentenced Milken to ten years in prison. Milken served only two years of his sentence behind bars.

Problems have also arisen with bonds issued by governments. For example, when California's Orange County issued $169 million in municipal bonds in June 1994, future taxes and other general revenues were expected to pay for the interest and principal of the bonds. But on December 6, 1994, the county filed Chapter Nine petitions in Bankruptcy court. The county could not pay the bondholders, since the money that had been set aside for them had been depleted. By 1995, losses in the Orange County investment pools approached $1.7 billion. Representatives of the county found themselves in court, being sued by the company that represented investors. In In re County of Orange, 179 B.R. 185, 26 Bankr. Ct. Dec. 1050 (Bankr. C.D. Cal. 1995), the bankruptcy court denied bondholders' claims to county revenues derived after the Chapter Nine filing. The interests of bondholders were seriously injured.

Nevertheless, bonds continue as popular investments. Junk bonds, especially, have regained favor as a means for earning considerable returns. The relatively high interest rates of junk bonds have entailed risks for buyers, but Wall Street analysts have argued that the rewards of these investment vehicles outweigh the dangers. Indeed, the bond market in general has even thrived in times of economic crisis.

Further readings

Geisst, Charles R. 1992. Entrepot Capitalism. New York: Praeger.

Platt, Harlan D. 1994. The First Junk Bond. New York: Sharpe.

Wurman, Richard S. 1990. The Wall Street Journal Guide to Understanding Money and Money Markets. New York: Access Press.

Yago, Glenn. 1991. Junk Bonds. New York: Oxford Univ. Press.

Cross-references

Securities.

See: bondage, constraint, durance, imprisonment, restriction, securities, servitude, ties
References in classic literature ?
Let it never be forgotten, that no slaveholder or overseer can be convicted of any outrage perpetrated on the person of a slave, however diabolical it may be, on the testimony of colored witnesses, whether bond or free.
They were knit together in a strict and sacred bond, to take care of the good of each other and of the whole.
If she could remove his bonds they might escape together--if she wished to escape.
And Monte Cristo placed the bonds in his pocket with one hand, while with the other he held out the receipt to Danglars.
Why not leave it and the goods on it to her and take the mortgages and bonds with him?
But the most ordinary cause of a single life, is liberty, especially in certain self-pleasing and humorous minds, which are so sensible of every restraint, as they will go near to think their girdles and garters, to be bonds and shackles.
The effort was powerful, prodigious, desperate; but the provost's seasoned bonds resisted.
For the dissemination of pure truth and to secure the triumph of virtue," he read, "we must cleanse men from prejudice, diffuse principles in harmony with the spirit of the times, undertake the education of the young, unite ourselves in indissoluble bonds with the wisest men, boldly yet prudently overcome superstitions, infidelity, and folly, and form of those devoted to us a body linked together by unity of purpose and possessed of authority and power.
she commanded them and then she stooped and cut the bonds securing her prisoner's feet and hands.
Roll over here," he said, "where I can get at your bonds with my teeth.
He could see a guard sitting before the door of his frail prison, but when he attempted to force the stout bonds that held him he realized that any extra precaution on the part of his captors was quite unnecessary; not even his giant muscles could part those numerous strands.
Trent stooped down and, picking up the knife, cut the bonds which had bound the boy.