When a company raises money by selling bonds, it’s important to remember that there are two types of risks involved: credit risk and interest rate risk. Credit risk is the risk that the company won’t be able to make the interest payments or repay the principal when the bonds mature. Interest rate risk is the risk that changes in interest rates will cause the price of the bonds to go up or down.
The relationship between these two types of risk is called the “principal-agent problem.” The principal-agent problem occurs when there is a conflict of interest between the person who owns an asset (the principal) and the person who manages that asset (the agent). In the case of bonds, the conflict arises because the bondholders are interested in getting their interest payments and their principal back, while the company issuing the bonds is interested in getting as much money as possible from selling the bonds.
The principal-agent problem is often solved by giving bondholders some kind of control over what happens with their money. For example, bondholders might have the right to vote on whether or not to sell new shares of stock. Or, they might have the right to elect a board of directors who will be responsible for making sure that the company doesn’t do anything too risky with its money.
The principal-agent problem can also be solved by having different classes of bonds with different rights. For example, some bonds might be ” secured” by collateral, which means that if the company goes bankrupt, those bondholders will get paid first. Other bonds might be ” unsecured,” which means that they’re just like any other debt that the company owes and they’ll only get paid if there’s anything left over after all of the other creditors have been paid.
There are many other ways to solve the principal-agent problem, but ultimately it comes down to giving bondholders some kind of control over what happens with their money. This way, they can make sure that their interests are being taken into account and that their money isn’t being used in a way that’s too risky.
What is a bond?
A bond is a debt investment, where an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a fixed interest rate.
What is a coupon?
A coupon is the interest rate paid by the bond issuer on the bond’s face value. The yield is the amount of return an investor realizes on a bond when held to maturity, and it takes into account the coupon rate as well as the effect of compounding.
What is the par value?
The par value of a bond is the face value of the bond that is printed on the bond itself. The par value is the amount that the holder of the bond will receive when the bond matures. The par value is also used to calculate the interest payments that the holder will receive during the life of the bond.
What is the maturity date?
The maturity date is the date on which the bond issuer must repay the bond’s principal, or face value.
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What is a principal?
A principal is the amount of money that is invested in a bond. The principal is what the bondholder will get back when the bond matures. The principal is also used to calculate the interest payments that the bondholder will receive.
What is the difference between a principal and an interest payment?
The principal is the original amount of money borrowed, while interest is the additional amount of money that must be paid in order to borrow the money. The interest rate is the percentage of the total loan amount that must be paid in interest.
What is the difference between a bond and a stock?
A bond is a debt investment, where an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities.
A stock is a share in the ownership of a company. When you buy stock, you become a partial owner of the company with a claim (dividends) on some of its profits. Unlike bonds, stocks usually have no set maturity date, so the holder’s claim on the company’s assets and earnings lasts indefinitely.
In conclusion, principal is the face value of a bond, and is the amount of money that will be repaid to the bondholder at maturity. Interest payments are made out of the bond’s coupon payments, and the principal is repaid at maturity. Principal can also refer to the amount of money invested in a bond, which may be different from the face value of the bond.