What is the advantage of issuing bonds instead of stock? | AccountingCoach (2024)

FAQs

What is the advantage of issuing bonds instead of stock? | AccountingCoach? ›

Bonds don't require payment of dividends. Bond prices do not fluctuate as much as stock. An advantage of issuing bonds instead of issuing common stock is that the return on common stockholders ' equity may be higher after bonds are issued.

Advantages of Issuing Bonds Instead of Stock

Interest on bonds and other debt is deductible on the corporation's income tax return while the dividends on common stock are not deductible on the income tax return.

Issuing more shares also means that ownership is now spread across a larger number of investors. That often reduces the value of each owner's shares. Since investors buy stocks to make money, diluting the value of their investments is highly undesirable. By issuing bonds, companies can avoid this outcome.

Bonds tend to be less volatile and less risky than stocks, and when held to maturity can offer more stable and consistent returns. Interest rates on bonds often tend to be higher than savings rates at banks, on CDs, or in money market accounts.

While stocks are ownership in a company, bonds are a loan to a company or government. Because they are a loan, with a set interest payment, a maturity date, and a face value that the borrower will repay, they tend to be far less volatile than stocks.

The disadvantages of corporate bonds: Although they are considered low-risk corporate bonds are not risk-free. The all-important ratings that are attached to bonds when they're issued can be lowered later due to unanticipated events. The worst-case scenario, a corporate bankruptcy, could erase your investment.

Stocks offer an opportunity for higher long-term returns compared with bonds but come with greater risk. Bonds are generally more stable than stocks but have provided lower long-term returns. By owning a mix of different investments, you're diversifying your portfolio.

A key disadvantage of bonds is that they are debt. The corporation must make its bond interest payments. If a corporation cannot make its interest payments, the bondholders can force it into bankruptcy. In bankruptcy, the bondholders have a liquidation preference over investors with ownership—that is, the shareholders.

If you buy bonds toward the end of a period when rates are rising, you can lock in high coupon yields and also enjoy the increase in the market value of your bond once rates start to come down.

Bonds offer investors regular interest payments, while preferred stocks pay set dividends. Both bonds and preferred stocks are sensitive to interest rates, rising when they fall and vice versa. If a company declares bankruptcy and must shut down, bondholders are paid back first, ahead of preferred shareholders.

What are the advantages and disadvantages of bonds? ›

Advantages include fixed income, capital preservation, diversification, and tax benefits, while disadvantages involve interest rate, inflation, reinvestment, and liquidity risks.

Given the numerous reasons a company's business can decline, stocks are typically riskier than bonds. However, with that higher risk can come higher returns. The market's average annual return is about 10%, not accounting for inflation.

Cons. Bonds are sensitive to interest rate changes. Bonds have an inverse relationship with the Fed's interest rate. When interest rates rise, bond prices fall.

Why buy bonds? Bonds are issued by governments and corporations when they want to raise money. By buying a bond, you're giving the issuer a loan, and they agree to pay you back the face value of the loan on a specific date, and to pay you periodic interest payments along the way, usually twice a year.

U.S. Treasuries are considered among the safest available investments because of the very low risk of default. Unfortunately, this also means they have among the lowest yields, even if interest income from Treasuries is generally exempt from local and state income taxes.

Each option has its advantages and disadvantages. Issuing bonds has the notable advantage of non-dilution of ownership because bonds do not represent an ownership stake in the company. Instead, they are a form of debt financing.

Preferred Stock vs Bonds

Unlike bonds, preferred stock is not debt that must be repaid. Income from preferred stock gets preferential tax treatment, since qualified dividends may be taxed at a lower rate than bond interest. Preferred stock dividends are not guaranteed, unlike most bond interest payments.