Difference Between Bonds and Loans

A bond is a type of debt instrument. It is a way for a company or government to raise money by selling, in effect, IOUs.

Bonds work by firms selling a bond for say £1,000. In return the firm agrees to pay back the bond in 10,20 or 30 years time. In the meantime, it will pay interest on this bond of say 5%. The purchaser of the bond, gives the firm £1,000 and in return gets interest payments for the duration of the bond term.

The main difference between a bond and loan is that a bond is highly tradeable. If you buy a bond, there is usually a market where you can trade bonds. This means you can sell the bond, rather than wait to the end of the 30 year period. In practise people buy bonds when they wish to increase their portfolio in that way.

Loans, tend to be agreements between banks and customers. Loans are usually non tradeable and the bank is obliged to see out the term of the loan.

However, instruments such as derivatives and securitisation have made loans more tradeable. Banks are able to pass on the risk of loans to other financial bodies willing to take on the risk.

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