Whether for personal, business or governmental needs, finance plays a vital role in the world economy. Significant personal, business and governmental projects cannot be completed without proper financing.
There are two primary ways a person, business, and government worldwide can raise capital. These are loans and bonds.
Through these monetary processes, the lender gives money to the borrower with some terms and conditions. The primary time and conditions for all cases are that the borrower will return the money with agreed-upon interest.
The process benefits both parties. As the borrower gets finance for his project, the lender also gets an opportunity to earn from his capital.
Due to this similarity, many believe that the loan and the bond are the same.
Key Takeaways
- A loan is a borrowing arrangement between a lender and a borrower, with a fixed repayment schedule and interest rate, often secured by collateral.
- A bond is a debt security issued by a corporation or government with a fixed interest rate and maturity date, which can be traded on secondary markets.
- Loans are direct agreements between lenders and borrowers, while bonds are marketable debt instruments, allowing investors to earn interest income and diversify their portfolios.
Loan vs Bond
The difference between Loan and a Bond is that a loan finance-raising procedure is for individuals and small business entities. In contrast, a bond is a capital-raising procedure for government, municipal agencies, and corporate entities.
Comparison Table
| Parameter of Comparison | Loan | Bond |
|---|---|---|
| Issuer | Financial institutions like banks. | Governments, municipalities, agencies, and corporate entities. |
| Duration | Short, medium, and long term | Mainly for a long time. |
| Tradability | No, loans are not tradable in any market. | Yes, on the bond market and over the counter. |
| Interest rate | Fixed or variable | Low-interest rate |
| Examples | Mortgage loans, car loans, credit card loans, etc. | Treasury bonds, zero-coupon bonds, corporate bonds, etc. |
What is Loan?
A loan is a debt instrument by which an individual, business entity, and government get capital from a financial institution. The money given by the financial institution comes with a term of repayment.
The borrower repays the loan with the principal amount and agreed-upon interest.
There are two types of loans, secured loans & unsecured loans. The financial institution or bank gives a fast loan in exchange for collateral, where the lender poses the right to acquire the collateral if the borrower fails to repay the money.
Mortgages and car loans are prime examples of secured loans.
The unsecured loan is given to the borrowerโs reputation, and any collateral does not support it. Signature loans and credit card loans are prime examples of unsecured loans.
Interest rates for secured loans are low, but the interest rates for unsecured loans are high. The interest can also vary on the market conditions.
Many secured loans are offered to the borrower with fixed-rate (where the interest rates remain constant throughout the lending period), or they might be flexible rates (where the interest rate changes upon the market condition).
Depending upon the conditions of the loan, the borrower repays the loan amount in instalments or revolving terms.
What is Bond?
A bond is a capital-raising tool by which governments and corporate business entities can gather investment from the financial market. Most bonds can be referred to as an I.O.U.
The borrower promises to return the money with matured interest on fixed tenure.
The benefit of a bond is that it is tradable in the bond market and over the counter. Here the lender does not have to wait for the fixed tenure to get back the money.
It can be enchased before its maturity date.
Bonds can be segmented into four prime categories. These are government, municipal, agency, and corporate bonds.
Bonds can be classified into different categories depending on the interest or coupon payment. These are zero-coupon, convertible, callable, and puttable bonds.
The inverse of the interest rates of a bond depends on the risk of returnโa bond with a high risk of return yields more inverse to interest rates.
For example, a government bond with higher payment chances is valued less. On the other hand, a corporate bond where the return of capital is risky is valued high.
Main Differences Between Loan and Bond
- The primary difference between the loan and bond is the issuer. Financial institutions like banks issue most loans around the world. Where the government, municipals, agencies, and corporate companies issue most bonds around the world.
- There can be various duration to repay the loans. It can be short, medium, and long-term loans. However, most of the time of bonds are for the long-term.
- Loans are not tradable in the market, but bonds are. Most bonds get traded in the bond market, where their prices fluctuate daily.
- There are two types of loans, secured loans & unsecured loans. The collateral of the borrower backs the secured loans, and the unsecured loans are backed by nothing but the borrowerโs reputation, where there can be various types of bonds like zero-coupon bonds, convertible bonds, callable bonds, and puttable bonds.
- Interest rates on most loans are fixed or flexible; with the fixed interest rate, the borrower has to pay the agreed-upon interest rate for the full duration of the loanโthe flexible interest rate changes upon the market condition. However, the interest rates on most bonds are low, and they are considered the safest investment.
- https://www.econstor.eu/bitstream/10419/45273/1/656652209.pdf
- https://dspace.tul.cz/bitstream/handle/15240/30584/242.pdf?sequence=1&isAllowed=y
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
