Comparison of a Bond vs. Promissory Note

Both bonds and promissory notes are financial instruments. These instruments are issued by organizations trying to raise money or control a certain aspect of their financial situation. They are bought by investors who are interested in a more dependable source of future income than stocks and are willing to lend money to the organization. However, the two function in slightly different ways and have different associations.

A promissory note is essentially a contract between two organizations, or between an issuer and a lender or investor, governing a one-time loan. The note specifies the terms of the loan, including the interest and maturity date, and binds both parties to a contract. This type of instrument is primarily used by businesses who cannot get loans from major lenders like banks and must investigate alternate means of financing.

Bonds, on the surface, are very similar to promissory notes, and they are often classified as types of promissory notes. However, there are a couple of key differences. First, bonds tend to have much longer maturity terms, often in excess of five years. Technically a promissory note is usually for less than five years, although these notes are still often called bonds. Second, bonds are released in an official, stamped and certified series, each bond being for a similar amount and on similar terms, while promissory notes are made on an individual basis.

Promissory notes are almost always issued by smaller companies and organizations; it is rare for large organizations with a large amount of equity to deal with promissory notes. Instead, they create corporate bonds, a popular type of bond often used by businesses to raise money. The government also tends to issue only bonds, although certain programs may offer promissory notes, and other governments have been known to issue notes instead of instruments in the bond fashion.

Since promissory notes are issued when the business cannot get a traditional loan, they are associated with greater risk. If the company had the means, it would issue a series of corporate bonds. A promissory note is usually needed for the business to continue with current operations. As such, the investors who buy the notes expect a greater rate of return and are usually experienced in buying and selling bonds and notes alike.

Both promissory notes and bonds must be registered in the country and state where they are issued. In the U.S., this is a safety issue. Regulators must review the notes to make sure the business has the ability to pay them back. Notes can be sold without being registered, but these notes are extremely risky, and the investor has no recourse if the company defaults. Bonds are always registered.