Bonds, Borrowing, and Lending, on Econlib.
A bond is a promise to pay. It is a promise to pay something in the future in exchange for receiving something today.
Promises—that is, bonds—can be bought and sold. The buyer of a bond is a lender. The seller of a bond is a borrower. The bond buyers pay now in exchange for promises of future repayment—that is, they are lenders. The bond sellers receive money now and in exchange for their promises of future repayment—that is, they are borrowers.
Bonds can be traded privately between individuals or in organized markets, called bond markets or credit markets.
You may not realize it, but you buy and sell bonds all the time! Every time you lend someone a few dollars for lunch or borrow your friend’s car in exchange for filling her tank, in economic terms you are buying and selling bonds. Simply remembering that bond buyers are lenders, bond sellers are borrowers, and that they are trading not pieces of paper but promises, can unlock the door to understanding both the vocabulary and the economics of a wide range of economic behavior, from private loans to interest rates to government budget deficits. It’s much easier to understand borrowing and lending than abstract vocabulary like “the bond market”—even though they are the same thing—because we can by think about our own familiar experiences with borrowing and lending….
When you use your credit cards or buy on installment, you are a borrower. In each case, someone—a bank or business owner—lends you the money by directly paying for the goods up front on your behalf. The lender later sends you a bill, at which time you are responsible to pay the principal and any accumulated interest to the lender. In economic terms, every time you use your credit card, you sell a bond—your promise to repay the credit card company in the future.
When you deposit money in a bank, you are a lender! In economic terms, you buy the bank’s bond— its commitment to repay you when you decide to use the money. The bank acts as an intermediary (a go-between) and pairs you with a borrower….
Here’s another example. When you buy a Treasury Bill, you are lending to the government. The government sells its promises to pay in organized markets each week….
Classroom activity. To illustrate these concepts in the classroom, I’ve often held a bond auction in class!
Interest, from the Concise Encyclopedia of Economics
Interest rates quoted by lenders usually include much more than “pure” interest. To persuade a lender to surrender current control of resources, the borrower will have to pay, in addition to interest, an amount that compensates the lender for any costs incurred in arranging the transaction, usually including some kind of insurance premium against the risk of default by the borrower. Someone without an established credit rating who applies for an unsecured loan will typically be required to pay “interest” at an annual rate that is several times the prevailing rate of pure interest….
FICO scores and credit bureaus, at Khan Academy.