- 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 – with annual interest payments.
- A loan is also a debt instrument, usually provided by a private bank with a variable interest rate.
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, the government/firm 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 until the end of the 30 year period. In practice, 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.
Interest rates on government bonds are usually lower. US and UK Government bonds are seen as low-risk. Private loans on unsecured debt are likely to attract higher interest. Corporate bonds are usually somewhere in between – depending on the reputation of the firm.
Bonds tend to be only repaid in full at the end of the period – e.g. 10, 20 or 30 years. Banks may expect repayment of both interest and principal during the repayment period.