Difference Between Loan and Bond

Edited by Diffzy | Updated on: April 30, 2023

       

Difference Between Loan and Bond

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Introduction

The economist is a wonderful creature of the financial world. The people who would like to grow their businesses would like to get a loan, and the people who have the most developed businesses would like to invest in upcoming companies. An economist's job is to bring the two ends closer together and make a deal out of it.

Bonds and loans have been around the world for thousands of years. And throughout the century, the graph of both bonds and loans has grown exponentially and has taken a big leap in the past few years. Since the beginning, the loan and bonds have been used for crucial funding for their business expansion, the start-up of the new firm, financial support for the family, and so on.

The bonds started around 2400 B.C.; the first bond ever recorded was a stone discovered at Nippur. This bond was a guarantee for the payment of the grains by the principal, and upon failing to make payment, the reimbursement was engraved as a surety bond. Later, the first government bond was issued by the Bank of England in 1693 to raise funding for the wars against France. And with this beginning in England, the trend spread throughout the world, and the United States began the bonds for the same purpose, the revolutionary war. In that year, when the US government issued bonds, private individuals bought more than $27 million in bonds to finance the war.

The loan, like many others, began thousands of years ago by trading grains and seeds for borrowing capital and livestock as repayment options. Loans can be traced back to 3000 years ago, and there has been lending and borrowing of some kind since then, which eventually took the final shape of the loan in today's world. The very first loan took place in 2000 BCE in Mesopotamia, where farmers used their payday loans. The loan had become widely available to middle-class families by 1800.

With the evolution of technologies, the paperwork carried out in the history of both loans and bonds has been reduced. Civilization and the economy have benefited from this ever-growing technology.

Loan Vs. Bond

To begin with, bonds and loans perform the same function of lending money at fixed or variable interest. But the interest on loans can be fixed or variable, whereas the interest on bonds is generally fixed. The operation of both terms is quite similar; just the durations, trading, sources, interest rates, owners, lenders, and risks can change with the respective needs of the issuer or holder.

The bond is a fixed-amount instrument that entitles the borrower, an investor, to borrow from a firm, corporation, or governmental body. A bond is usually given to an industrialist or business tycoon since they have a reputation for earning, and one promising factor is that future repayment is in secured hands. The amount given to a firm, company, or business tycoon holds the interest rate, which differs based on factors such as the amount of money, duration, work, current market circumstances, and so on.

A loan is similar to a bond in that it involves lending money with interest. Loan interest can be fixed or variable, but bond interest can now vary as much as loan interest. The loan can be provided by financial institutions or a private lender who earns a profit solely on interest. A contract is made between the lender and the issuer; every little detail is mentioned, including the date of issuance and maturity, the interest charged, the escalation cost, and so on.

Difference Between Loan and Bond in Tabular form

Parameters Laon Bond
Meaning A loan is when one party agrees to give another party a sum of money that is to be paid back after a certain period. The bonds are debt instruments; when an investor purchases the bond, they are loaning the money to the bond maker, which might be the government or a company.
Sources Loans are given by financial institutions, banks, or other private lenders. The bonds are sold and bought in the bond market.
Interest rates The interest on the loans can be variable or fixed. The interest on the bonds is usually fixed.
Trade The loans once taken by the issuer cannot be sold, but the issuer will have to repay the amount on agreed-upon terms. The bonds can be sold to anyone before the maximum term of 30 years.
Risks The risk factor depends on how secure and unsecured the loans are; the more secure, the less risk; the more unsecure, the more risk. The interest rate of the bonds is quite low, and it is considered an investment rather than a loan; hence, the associated risk is low.
Ownership Corporates or individuals borrow them from banks or private lenders. The governments or firms sell the bonds to the promising participant.
Examples Personal loans, term loans, cash credits, etc. 3-year capital gain bonds, US treasury bonds, asset-backed securities, etc.
Used for The loans are usually taken by families, start-ups, and some companies. The bonds are taken by the wealthiest families, well-established firms, and business tycoons.

What is a Loan? 

A loan is an act of lending money by one or more individuals or organisations to other individuals, organizations, etc. When an individual borrows money, he incurs a debt and is also liable to pay interest on the debt until the debt is fully paid. The interesting fact is that the interest provides an incentive for a lender to engage in lending money to an individual in need. And it is a win-win situation for both parties to the deal.

Depending on the type of loan, there can be restrictions and obligations for the borrower. Considering the loan is a legal loan, the borrower may face additional restrictions enforced in the contract, and such restrictions are known as loan covenants.

There are various types of loans that fall under secured and unsecured loans, and besides that, there are a few other loans such as demand loans, subsidised loans, concessional loans, and so on. Moving further, let's see how secured and unsecured loan’s function:

Secured Loan 

A secured loan is lent to the borrower when the borrower pledges some assets as collateral. As in lending agreements, collateral serves as a lender's protection against a borrower's default and so can be used to offset the loan if the borrower fails to pay the principal amount with interest.

The mortgage loan is the main type of secured loan. Many individuals take advantage of this loan by buying residential and commercial properties. A car loan too falls under the secured loan category, where people buy an automobile or car with the loan. The interest rates of a car loan and mortgage can differ by a moderate percentage.

The lien is a security interest granted over the item purchased with the loan, in which when the borrower fails to repay the debt along with the principal interest rate, the financial institution is intended to seize the property and sell it to recover the sum owing. The other forms of loans that fall under the category of secured loans are securities, such as shares, mutual funds, bonds, and so on. The interest rate of secured loans is comparatively lower than that of unsecured loans.

Unsecured Loans 

As we know, secured loans engage the borrower's assets, but in monetary loans, the loans are not secured by any of the borrower's assets. Unsecured loans are available in financial institutions under various guises, such as credit cards, personal loans, bank overdrafts, corporate bonds, and so on. Considering the risk to the lender, since there is no asset involved for the borrower to use as recourse in the event of default, the interest rate on such loans is always high.

What is a Bond?

The bond in finance is also a type of security in which the money is loaned to the holder by the issuer and the holder is responsible to pay it back with interest for the decided period. The interest can be paid at a specific interval, like monthly, quarterly, semi-annually, or even annually. Thus, the bond is a type of loan and, in some states, is also known as an IOU (I owe you), which is dissected as an informal document acknowledging the debt. The bonds are usually used for further long-term investment by companies or even as government bonds to finance expenditures.

The word "bond" relates to the word "bind," which in turn took on the sense of "an instrument binding one to pay a sum to another." This was in the 1590s. This one sentence clarifies the definition of bonds to us. As aforementioned, the bond is security as well, just like stock, but unlike stockholders, who are owners of the company, bondholders are creditors of the company. Hence, in the event of bankruptcy, the bondholders have the upper hand since they are the creditors and get the secured interests.

The bond is issued by underwriting. Once the bond issue is underwritten, the investment firms buy the bond, form a syndicate, and resell the entire issue of bonds to the investors. But the government bonds are issued in an auction. For such bonds, the bidder can be both public and private banks, and in other cases, the same can be bid by market makers.

The issuer of the bond is obligated to pay the nominal amount at maturity. There is no further obligation between the issuer and the bondholder following the completion of the payment and transaction. The various types of bonds in terms of time are as follows: Short-term: zero to one year for maturity; medium-term: one to ten years for maturity; long-term: ten to thirty or even fifty years for maturity; and last but not least, perpetual: no maturity period.

Main Difference Between Loan and Bond in Points

  • A loan occurs when both the holder and the issuer agree to lend and receive money at a fixed interest rate. The bonds, on the other hand, have a fixed term, so an interested and promising participant gets the benefit of the bond.
  • The bonds are highly tradable, meaning they can be sold to another participant in the bond market rather than waiting for thirty years. Loans, on the other hand, are not tradable at all, and the lender or bank will be obliged to see the entire term of the loan.
  • The bank's repayment system works as per the terms and regulations, and any additional terms agreed upon beforehand can be on a monthly, quarterly, or even yearly basis. The bonds are only to be repaid in full at the bond's maturity, i.e., 10, 20, or 30 years.
  • The bonds are rather considered investments than debt instruments; even the US and UK bonds are treated as low-risk. Government bonds are usually low-risk, and corporate bonds can vary depending on several market factors and the reputation of the company. Whereas, in the case of loans, secured loans are low-risk and unsecured loans are higher risk.
  • For corporations, bonds are the safest and most reliable option, as the interest rate they'd have to pay on bank loans is far higher than what they'd have paid to the bond investors.
  • The corporation also becomes free of any excess limitations that were being imposed while loaning money from the bank. But the bonds have saved that area too for corporations since there are no such limitations.
  • The bonds that are traded in the bond market may have credit ratings, which are issued by credit rating agencies and range from investment grade to speculative grade. However, there is no such term valid in the case of loans.
  • Loans can be secured by collateral, such as a mortgage, or unsecured, such as a credit card. However, the collateral is not highly involved in the terms and regulations of bonds.

Conclusion

Both loans and bonds have quite similar features, and both provide some beneficial outcomes that are unique in a way. Bonds are debt instruments of low-risk investment that are sold in the bond market by private individuals or government bodies; one can also receive interest payments on them.

Loans, on the other hand, are available in banks and financial institutions for private individuals who require financial assistance, and the same amount is repaid with the previously agreed-upon terms and regulations of interest rate and other factors.

A financial goal is to select the debt that best meets your needs. Since there are a variety of loans available today in the market, it is feasible to understand the differences and make the right choice to achieve financial freedom.

References

  • Loan - Wikipedia
  • Bond (finance) - Wikipedia
  • Bond vs Loan | Top 7 Best Differences (with Infographics) (wallstreetmojo.com)
  • Bond vs Loan | Top 9 Differences to Learn (With Infographics) (educba.com)
  • Difference Between Bond and Loan, Bond vs Loan (moneyview.in)

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"Difference Between Loan and Bond." Diffzy.com, 2024. Thu. 22 Feb. 2024. <https://www.diffzy.com/article/difference-between-loan-and-bond-1132>.



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