How can Small Comapnies Take Advantages of Issuing Bonds by Large Comapnies?
Big businesses get many options for raising funds, of which issuance of long term bonds is an important one. Long term bonds are classified among debt instruments and have a maturity period of four to five years. However, bond markets are not accessible to small companies, especially the newer ones. Yet, such companies derive financial benefits from long term bonds.
Important issues concerning issuance of long term bonds are various conditions stipulated by governments, publically traded companies and private companies. Compared to short term financial instruments like treasury bills and deposit certificates, the rates of interest for long term bonds are usually higher. Bonds involving high element of risk, like junk bonds, need to pay superior rates of interest to remain attractive for investors.
For small business, one of the advantages of issuing bonds by big companies is that by investing its surplus funds in long term bonds it can count on getting a regular income by way of interest payable by the bond issuer. Usually, such interests are paid twice a year. When the market rate of interest goes up, the prices of long term bonds come down, whereas their yield, arrived at by dividing the interest payment by market price, goes up to match the ongoing market rates. On the other hand, when market rates of interest start falling down, the price of bonds starts going up and their yield is reduced. Here’s an example to explain this phenomenon. Consider a bond worth $100,000 having a maturity period of ten years and paying @ 5 percent/annum. So, annual income from this bond will be $5,000. With rising rate of interest, the market price of bond is reduced to $97, 5000, but its yield becomes $5,000/$97, 5000=5.13%.
For taking advantages of issuing bonds, small businesses, rather than keeping all their surplus funds in long term bonds, should have a versified portfolio, comprising of stocks, treasury bills plus mutual funds. That is because with diversified portfolio small business gets an opportunity of maximizing returns from its surplus funds, yet having sufficient liquidity for taking care of its operational requirements and tactical opportunities. Another significant advantage of such portfolio is that it reduces the elemental risk, so that even if the value of one of their assets comes down, their investment portfolio in totality is not so harshly affected.
Upcoming small or medium sized companies, unlike big companies, can’t take advantages of issuing bonds to raise funds through equity markets or long term bonds. Nor they can approach friends and family for financial support, like newbies. Though businesses falling in these categories are unable to access capital markets, they can certainly look forward to getting financial help from some of the regulations such as 504 fixed-rate long-term loans for expansion plans and capital investments and Certified Development Company as set forth by U.S. Small Business Administration.