us treasury | Nesteggg Accounting

You may have heard of stocks and bonds but do you know the difference? A few months back we talked a little bit about what a stock is (click here to read the post) so now let’s take a look at bonds.

One of the primary differences between a stock and a bond, at its most fundamental, is that when you hold stock you own a portion of the company. When you hold a bond what you have is a loan to that company.

Why Bond?

If you are a company and you need money to do research or purchase new equipment you might sell off some of your company as stock. This will bring in cash that is outside of normal business income. But then you, the company, are in a position where several other people now have an ownership stake, possibly with rights to vote on the direction of the company. Maybe you don’t want that, or you’ve got no stock left to sell. Or, maybe your company’s reputation or growth potential is not what it should be to bring in the amount of cash you need. Then you might opt to issue a bond.

Essentially a bond is an instrument wherein the purchaser is told up front what the face value of the bond is, and when exactly it will be paid back, and what percentage will be earned and when those payments will be made. This is good for the company because it knows exactly what and when it will owe back to the bond holders.

Why not just borrow from a bank, you may wonder? It may be difficult for a company to borrow enough cash from a bank, especially if the amount is quite high. And in the case of the government it can’t exactly borrow from itself so it issues bonds to do things like build roads and build schools.

Upside Downside

For the investor, a bond is often considered “safe”. This is because of the certainty of the payback arrangement. However, that portion of cash is tied up in that instrument for a fixed time frame. Those funds tied up in bonds then can’t be used to purchase stock or put a down payment on a house, for instance. And, if you are able to sell your bonds you may have to take less than you would have received if they were allowed to come to maturity.

Sources

Where do bonds come from? There are several different entities that can issue a bond.

Government –The U.S. can issue bonds and these are generally considered the most secure of financial instruments.

Municipal – These can also be local governments, states, and municipalities.

Corporate – These are issued by corporations and can be sold either on a public market or “over the table” – essentially a private market where bonds are bought and sold.

Agency – These are bonds issued by government agencies, like the water company.

Types

Now that you know where bonds come from you might have heard a few types which we can illuminate. Of course, as with all financial instruments within these types are several sub-types and details, too many to discuss here.

Puttable – This is a type of bond where you can sell it back to the company before the maturity date.

Callable – This is a type of bond where the company can pay you back earlier than the maturity date.

Zero-Coupon – “Coupon” is what the percentage periodically paid out is named. So, a zero-coupon bond is one where there is no percentage paid out. But it is sold at a lower rate than the face value. So, you may purchase a bond worth $100 for $98.75. When it matures you will get back your investment of $98.75, plus $1.25.

Convertible – These are bonds that can be turned into stock, and how and when that is done can be very complicated, but suffice to say that this type of bond allows one to go from a lender to and owner of the company.

It may seem like the dollar – the U.S. currency – has been around forever. But in our country’s infancy we had a different currency called the Continental currency, or Continentals. And even before Continentals, the colonies issued their own currency to finance things like military campaigns, buildings, and pay government officials and the like. Also, bills of credit were issued by the government and by the states. Those were, in essence, promises to pay a debt. There was not much coinage (actual coins made of metal) minted by the U.S. in those early years.

The Continental

Continentals were issued by Congress in large part to fund the Revolutionary War against the British. When Congress deemed it needed more money for the war, it printed and circulated more Continentals. Thus, by the time the war was winding down there was too much paper currency and bills of credit in circulation. There was also a problem of counterfeit currency on the market. And by that time, Continentals were worth almost nothing.

Many attempts were made to shore up the currency to no effect. When the Continental Congress then ratified the Constitution, it included language prohibiting the states from issuing their own currency, limiting the number and type of currency in circulation. An attempt also was made to take old currency out of circulation in order to make what was left more valuable. However, none of these efforts worked effectively.

After the Revolutionary War wrapped up Congress appointed a Superintendent of Finance to monitor monetary policy and a few years later the U.S. authorized a new currency, the U.S. Dollar.

Pieces of Eight

Why “dollar” and not “pound”? We were a British colony after all. Well before and during the war, much of the coinage in circulation were Spanish pesos and eight of them were called a dollar (pieces of eight refers the fact that Spanish currency is divisible by eight). In fact, most of the coinage circulating of the time was from somewhere else, not minted here. Thus, when it came time to create a national currency, Congress chose a moniker that was already in circulation. Fun fact: the Spanish dollar was still legal tender in the U.S. up until 1857.

Back when the Continental Congress ratified the Constitution it also included language that connected the dollar to the value of gold and silver. And our dollar was backed by gold and/or silver for a long period of our history until 1971 when our currency fully became fiat currency rather than currency backed by commodity.

What is the difference you may ask. Commodity currency is backed by a thing of value, like gold or silver. But, if your currency is backed by a thing – even if that thing is shiny and pretty and worth a lot – there are only so many of those things. And if you come to the end of your things to back your currency then you must limit growth. Or worse, devalue your currency.

Gold Standard

The U.S. dollar being backed gold and silver is not as straight a line as some may believe. At times of war and heavy financial pressure the government could and did issue treasury bonds backed only by the government. Fun Fact: for a long time one could take one’s dollar bills into the Federal Reserve bank or one of the Regional Reserve banks and request they be exchanged for gold or silver. In 1900 silver was detached from it and only gold was used to back the dollar. There were several variances in the valuation of a dollar linked to gold until finally in 1971 the dollar was allowed to become fiat currency.

A fiat currency, which most of the world’s currencies now are (remember our discussion of Bitcoin?), is backed by an entity. In our case, the dollar is backed, as it states on bills by “the full faith and credit” of the U.S. So, now instead of things of value determining how much our currency is worth, the stability of the entity determines (among many other factors) the value of the dollar. This is where the Federal Reserve comes in. As the central bank of the U.S. it alone determines monetary policy and thus how much cash and debt is in the market at any given time.

What is a Bond anyway?

A Brief History of the Buck

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