Serial bonds

Serial bonds

Serial bonds are referred to as bonds where a portion of the bond will be restructured into small amounts that are paid off at regular intervals. This causes the total amount of the bond to decrease gradually, and the buyer gets a regular stream of income coming in. 

What is a Serial Bond? 

A serial bond is often described as a security bond that will repay at regular intervals until the maturity date arrives, and by then, the entire amount will be paid off. Unlike term bonds where the entire principal amount is paid off as a one-time payment at the time of maturity, serial bands provide the opportunity to pay off smaller chunks of the amount as instalments that are paid once or twice a year. The exact amount and schedule of these instalments are specified in detail on the bond indenture. 

Understanding Serial Bonds 

As serial bonds provide regular payoffs instead of a one-time payment at the time of maturity, they can be an attractive option for some investors. Serial bonds were created with the goal of providing a steady cash flow that many capital projects desire. Since the principal amount is divided into smaller chunks and paid off regularly, the amount of money that the issuer needs to pay in the end is reduced dramatically. This ensures that the issuer has no risk of missing any payments.  

These bonds are issued by the central government, municipality or even public or private projects. Projects of large scale often require a lot of cash flow during the initial stages of the project, but once the project is live, they begin generating profits that can be used to pay off the debt in small but regular intervals. This would drastically reduce the burden on them. 

Advantages of Serial Bonds 

In serial bonds, the principal amount is divided into smaller chunks that are paid off regularly, which reduces the principal amount gradually. So, one key advantage of serial bonds is lower interest. Also, since the interest rates are calculated with respect to the principal amount, the interest amount will decrease as the principal amount decreases after every payoff. On top of that, since the repayment liability decreases at regular intervals, the risk of defaulting on the payment is lower. 

It also allows you to diversify your investment portfolio. Serial bonds are often called security bonds as they can help cover your finances in case some of your other investments fail. Not to mention, serial bonds can be quite lucrative for investors who are looking to diversify their investment portfolio. The interest rates also play a role in attracting more investors. Serial bonds with shorter maturity tend to have much lower interest rates and are attractive to investors.

Disadvantages of Serial Bonds 

If you are buying serial bonds for a project, then you have to be sure it can generate enough profits to pay off the debts. Also, serial bonds may not be appropriate for every project. So, if you are unsure if the project will be able to generate enough profits, or if there’s a delay or certain uncertainty, buying serial bonds is not recommended. 

Example of Serial Bonds 

Suppose a bond issuer provided a generous bond of US$5 million in 2020 at a 10% interest rate, which was not uncommon. And this 10% interest rate was annually payable for 5 years from 2023. 

 

Date  Repayment Amount  Outstanding Amount  Interest Amount Annually 
Dec 2023  0  US$ 5 Million  US$ 500,000 
Dec 2024  US$ 1 Million  US$ 4 Million  US$ 500,000 
Dec 2025  US$ 1 Million  US$ 3 Million  US$ 400,000 
Dec 2026  US$ 1 Million  US$ 2 Million  US$ 300,000 
Dec 2027  US$ 1 Million  US$ 1 Million  US$ 200,000 
Dec 2028  US$ 1 Million  0  US$ 100,000 

 

So, for the first 3 years, you would not need to pay anything. You would only start paying in 2023 and for that year, you would only need to pay the interest amount, which was US$500,000. For next year, it would be a small portion of the principal amount and the interest amount, which was US$1.5 million and a balance of US$4 million would remain. For 2025, you would need to pay US$1.4 million and a balance of US$3 million would remain. For 2026, you would need to pay US$ 1.3 million and a balance of US$2 million will remain. For 2027, you would need to pay US$1.2 million and a balance of US$  million will remain. For 2025, you would need to pay US$ 1.1 million and your debt would be paid entirely. 

Frequently Asked Questions

In a sinking fund issue, an investor will purchase a security that has a known maturity, while in a serial bond issue, there will be multiple maturity dates and the principal amount decreases over time. 

A sinking fund refers to the fund that you stow away only to be used by a trustee to retire some bonds by purchasing them from a bondholder. Serial bonds, on the other hand, are different from sinking funds. It is created to retire bonds according to the provided routine. However, the remaining amount of both bonds will decrease gradually. 

 

Term bonds and serial bonds are the complete opposite of each other. In a term bond, you pay the maturity amount entirely in one go at the time of maturity. However, serial bonds have multiple maturity dates and you pay off each maturity amount on its particular day, so there’s no single big payment. 

Here are some of the possible limitations of serial bonds: 

  • It is tied to a particular project. 
  • It Carries a certain reinvestment risk. 
  • It is not ideal for short-term investments. 
  • There is a risk of generating lower yields. 

Serial bonds have multiple maturities, where you will have to pay off a portion of the principal amount every year along with the interest. This needs to be paid every year until the entire principal amount and the interest is paid off. However, with term maturity, there’s only maturity and that’s at the end of the term.  

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