Types of Bonds

Types of Bonds

Today, many individuals are unable to afford essential assets such as vehicles or real estate and therefore require loans. Likewise, businesses need financing to expand their operations or generate profits.

The financing required by businesses is often beyond the capacity of banks. In such circumstances, companies rely on alternative methods to secure funding and achieve their objectives.

One of the most common instruments used for this purpose is bonds.

Types of Bonds in Iran

Concept of Bonds

A bond is a form of investment under which an investor provides a specified amount of capital to a natural or legal person. In return, the issuing company or borrower agrees to repay the principal amount, along with periodic interest, within a predetermined time frame.

Callable Bonds

Callable bonds give the issuing company the right to redeem them at its discretion before maturity.

This option is typically exercised when interest rates decline, allowing the issuer to refinance its obligations by issuing new bonds at lower rates and thereby retain more capital.

This mechanism may benefit both the issuer and the bondholder, as the bondholder may receive higher returns under favorable conditions.

Putable Bonds

Certain bonds provide the holder with the right to sell the bond back to the issuer at its nominal value prior to maturity.

This right cannot be exercised at any time and is subject to specific conditions and predetermined time periods.

Convertible Bonds

Some bonds may be converted into company shares. Upon issuance, the exact time frame and conversion price are clearly specified. These bonds typically offer lower interest rates while providing greater potential access to ordinary shares.

Secured Bonds

Secured bonds are backed by collateral. The issuing company guarantees that it holds sufficient assets to cover the bonds’ value and assures bondholders that, in the event of bankruptcy, those assets will be allocated to satisfy bondholders’ claims.

Unsecured Bonds

Unsecured bonds are not supported by collateral and rely solely on the creditworthiness of the issuing entity. Government bonds generally fall into this category and are considered reliable because they are backed by the state.

Categories of Bonds

• Government Bonds: Government bonds are issued to finance public programs and meet expenditure obligations, including salaries and other public expenses.
• Municipal Bonds: Municipal bonds are issued by countries, states, regions, or cities to finance public projects and operations such as the construction of schools, hospitals, power plants, roads, administrative buildings, airports, and bridges. These bonds are typically issued when tax revenues are insufficient to cover project costs. Interest earned on municipal bonds is generally exempt from federal income tax.
• Corporate Bonds: Corporate bonds are issued by companies or other business entities to finance operations and cover expenses. These bonds carry higher risk than government bonds but usually offer higher returns. They are available in various forms and are generally subject to higher taxation.
• Characteristics of Bonds: Interest paid to shareholders does not apply to bondholders, as bondholders do not possess ownership rights in the issuing company.
  • Bonds have a defined maturity date. Some mature gradually, while others mature on a single specified date.
  • In certain cases, companies issue bonds to increase their attractiveness and investor incentives.
  • Bondholders typically have voting rights only in cases such as company mergers or the issuance of new bonds.
  • In private bond offerings, only the issuer and the purchaser may transfer the bonds.
  • The rights of bondholders are determined by contract, including the right to receive the nominal principal amount and the agreed interest.

Difference Between Bonds and Shares

• For shares, returns are not fixed and depend on the company’s performance and profitability. By contrast, bonds offer a fixed rate of return.
• A shareholder owns a portion of the company and shares in both profits and losses. A bondholder, however, is merely a creditor of the company.

Important Note: Due to the fixed interest rate associated with bonds, they have been deemed non-compliant with Islamic principles by the Guardian Council and therefore do not formally exist under Iranian law. Instead, alternative financial instruments such as participation bonds and other Islamic securities have been introduced, which differ in nature and comply with Sharia principles.

Frequently Asked Questions About Types of Bonds