How it works

Just as it does when issuing stock, a corporation that intends to issue bonds partners with an underwriting firm that purchases the bonds from the company and then sells them to investors. In return for taking on this financial risk, the company issuing the bond pays the underwriting firm a fee.

Working with the underwriters, the company will determine the term of the bond, or the number of years before the bond’s face value will be paid to the holder, as well as the coupon, or interest rate that the bondholder will earn.

Municipal bonds issued by state and local governments are also brought to market as needed by underwriters. But U.S. Treasury issues are auctioned to institutional and individual investors on a regular schedule, from as frequently as once a week for bills to as infrequently as quarterly for 10-year notes.

Determining interest

For corporate bonds, the interest rate is usually linked to the term and the financial risk that the holder undertakes: The higher the risk that the company won’t be able to meet its debt, the higher the interest rate. The underwriters then distribute the bonds to their associated brokerage firms, who typically sell the bonds to institutional or individual investors at the par, or face value — in most cases $1,000 per bond.

The same factors influence the cost of municipal bonds, though their rates are generally lower than similarly rated corporate bonds because the interest they pay is tax deductible to investors. Rates on Treasury bonds, in contrast, are affected by term but not rating as they are considered free from default risk.

Professor
Samuel L. Hayes,
Harvard Business
School

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