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A simple example will illustrate the process for issuing bonds.
Example
ABC Company needs capital to purchase a new piece of equipment
for its operations. The company meets with financial advisors and
investment bankers to discuss the possibilities of raising the necessary
capital. They decide that a bond issue is the least expensive method for
the company. The process is as follows:
Terms
1. ABC Company sets the maturity date and face value of the bonds.
The bonds will have a maturity date of ten years from the date of
issue and a face value of $1,000. The company will issue as many
bonds as it needs for the equipment purchase if the equipment
costs $10,000,000 fully installed, then the company will issue
10,000 bonds.
Coupon rate
2. Investment bankers set the coupon rate for the bonds.
The investment bankers attempt to gauge the interest rate
environment and set the coupon rate commensurate with other
bonds with similar risk and maturity. The coupon rate dictates
whether the bonds will be sold in the secondary market at face
value or at a discount or premium. If the coupon rate is higher than
the prevailing interest rate, the bonds will sell at a premium; if the
coupon rate is lower than the prevailing interest rate, the bonds will
sell at a discount.
Primary issue
3. Investment bankers find investors for the bonds and issue them in
the primary market.
The investment bankers use their system of brokers and dealers
to find investors to buy the bonds. When investment bankers
complete the sale of the bonds to investors, they turn over the
proceeds of the sale (less the fees for performing their services)
to the company to use for the purchase of equipment. The total
face value of the bonds appears as a liability on the company's
balance sheet.
Secondary market
4. The bonds become available in the secondary market.
Once the bonds are sold in the primary market to investors, they
become available for purchase or sale in the secondary market.
These transactions usually take place between two investors one
investor who owns bonds that are no longer needed for his/her
investment portfolio and another investor who needs those same
bonds.
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