Bonds

Written documents by which a government, corporation, or individual—the obligor—promises to perform a certain act, usually the payment of a definite sum of money, to another—the obligee—on a certain date.

In most cases, a bond is issued by a public or private entity to an investor who, by purchasing the bond, lends the issuer money. Governments and corporations issue bonds to investors in order to raise capital. Each bond has a par value, or face value, and is issued at a fixed or variable interest rate; however, bonds often can be purchased for less or more than their par value. This means that the yield, or total return on a bond, varies based on the price the investor pays for the bond and its interest rate. Generally, the more secure a bond is (i.e., the stronger the assurance that the bond will be paid in full upon maturity), the less the bond will yield to the investor. Bonds that are not very secure investments tend to have higher returns. Junk bonds, for example, are high-risk, high-yield bonds. Except for the high-risk variety, bonds tend to be relatively solid, predictable investments, with prices that vary less than those of those of stocks on the STOCK MARKET. As a result, litigation because of unpaid bond agreements has rarely proved necessary.

The most common type of bond is the simple bond. This bond is sold with a fixed interest rate and is then redeemed at a set time. Several varieties of simple bonds exist. Municipal governments issue simple bonds to pay for public projects such as schools, highways, or stadiums. The U.S. Treasury issues simple bonds to finance federal activities. Foreign governments issue simple bonds, known as Yankee bonds, to U.S. investors. Corporations issue simple bonds to raise capital for modernization, expansion, and operating expenses.

Conditional bonds do not involve capital loans. Most of these bonds are obtained from persons or corporations that promise to pay, should they become liable. The payment is usually a nonrefundable fee or a percentage of the face value of the bond. A bail bond is a common type of conditional bond. The person who posts a bail bond promises to pay the court a particular sum if the accused person fails to return to court for further proceedings on the date specified. Once a bond payer satisfies the terms of a conditional bond, the liability is discharged. If the bond goes into default (i.e., if the obligations specified are not met) the amount becomes immediately due. Parties also can mutually decide to cancel a conditional bond.

The emergence of simple government and corporate bonds into the modern marketplace began with the economic boom of the 1920s.

Immediately after WORLD WAR I, the U.S. economy rewarded investors who were eager to see expansions in industrial growth. For most of the 1920s, until just before the Great Depression, interest rates remained low. The bond market became sophisticated enough to raise funds for the U.S. Treasury, domestic corporations, and foreign borrowers. It also proved useful during WORLD WAR II, when the federal government depended on the sale of war bonds to finance its military efforts.

During the 1980s, a different kind of boom in the U.S. economy sent the bond market in a more problematic direction. Even though high-yielding bonds tend to be less reliable investments than low-yielding ones, the rapidly increasing business activity in the 1980s led to large-scale buying of these high-risk investments. Corporations successfully bought out the stock of other corporations by raising money through the sale of millions of dollars of junk bonds. (Junk bonds have been given low ratings when measured by standard investment criteria—hence the pejorative name.)

Troubles soon arose from the shaky foundation of the JUNK BOND market. One of the country's leading figures in fostering junk bond investments, Michael R. Milken, faced criminal charges that he had manipulated bond prices, traded on inside information, and bribed investment managers. Milken's image was further complicated by his having worked with the stock baron Ivan F. Boesky, who had been convicted of insider trading. In April 1990, in Securities & Exchange Commission v. Milken, 1990 WL 455346, Fed. Sec. L. Rep. ¶ 95,200 (S.D.N.Y. April 24, 1990), Milken pleaded guilty to six felonies, including conspiracy, SECURITIES FRAUD, and aiding and abetting the filing of a false document with the SECURITIES AND EXCHANGE COMMISSION. At the time of the initial settlement, Milken agreed to pay $600 million in fines and reparations. In November 1990, federal judge Kimba M. Wood sentenced Milken to ten years in prison. Milken served only two years of his sentence behind bars.

Problems have also arisen with bonds issued by governments. For example, when California's Orange County issued $169 million in municipal bonds in June 1994, future taxes and other general revenues were expected to pay for the interest and principal of the bonds. But on December 6, 1994, the county filed Chapter Nine petitions in BANKRUPTCY court. The county could not pay the bondholders, since the money that had been set aside for them had been depleted. By 1995, losses in the Orange County investment pools approached $1.7 billion. Representatives of the county found themselves in court, being sued by the company that represented investors. In In re County of Orange, 179 B.R. 185, 26 Bankr. Ct. Dec. 1050 (Bankr. C.D. Cal. 1995), the bankruptcy court denied bondholders' claims to county revenues derived after the Chapter Nine filing. The interests of bondholders were seriously injured.

Nevertheless, bonds continue as popular investments. Junk bonds, especially, have regained favor as a means for earning considerable returns. The relatively high interest rates of junk bonds have entailed risks for buyers, but Wall Street analysts have argued that the rewards of these investment vehicles outweigh the dangers. Indeed, the bond market in general has even thrived in times of economic crisis.