Definition of Bullet Bonds
Bullet bonds make a coupon payment on every coupon date, and the entire principal amount is paid back to the bond holder only on maturity. Bullet bond makes periodic interest payments. These bonds are also known as straight bonds because they do not contain any embedded features with them, such as put or call. The government uses these bonds to meet the expenses of the public projects.
Bullet bonds are also known as straight bonds. These bonds are issued mostly by the government entity, and the periodic interest payment is there. The principal amount is paid at the end of the maturity date. Bullet bonds have less coupon rate than any other bonds in the market. Bullet bonds are very commonly available for the public. The bullet bonds do not contain any additional feature or embedded feature, such as the call or put option. The bullet bonds have a very high counterparty risk as the principal payment is made at the end of the maturity date. These bonds are issued to help the public sector companies when they have some ongoing projects.
How Does It Work?
A bullet bond is a debt instrument which is also known as straight bonds. These bullet bonds are easily available in the market. The bullet bonds are generally available with the government companies/entities. The periodic interest payment is present in bullet bonds, and the principal payment is done at the date of maturity. It is a straight bond because it does not carry any embedded feature to it. It is a whole sole bond which has a very simple payback system, and the investors easily understand it.
Example of Bullet Bonds
Mr. Joe wants to invest in a bullet bond, and therefore he has invested $1000. The coupon rate of the bond was 10% per annum. The bond will mature at the end of 5 years. Now we have to tell him about the interest he will get and his principal amount payback.
Therefore, at the end of the maturity date, after 5 years’ time, Mr Joe will receive $1100 and the periodic interest of $100 every year. So, in this case, he will gain $500 in 5 years’ time from bullet bond.
Bullet Bonds Strategy
The investor invests in the particular bond, and they get periodic payments, and the entire principal amount is paid back at the end of the maturity date. The strategy of this type of bonds are such that they create earnings at the maturity date, and all the bonds have the same maturity date, whereas the investment can be at any point of time. The logic behind the issuance of the bullet bond is that it will create earnings for the government entity if any project is undergoing for the public welfare.
Bullet Bonds Graph
Graph of bullet bond are:
|Face Value ($)||1000|
|No. of Coupon payments||10|
|Maturity in years||10|
|Years||Coupon Amount ($)|
The bullet bond in this graph has a face value of $1000, and the coupon rate is 5%. The interest is paid annually, and therefore the coupon amount is $50, which will pay every year. At the end of the maturity period that is 10 years, the entire amount, including the principal and the interest, will be paid back to the investor. The graph shows the exact picture of the coupon rate and the principal repayment.
Some of the benefits of bullet bond are:
- The concept of bullet bonds is very easy to understand for any type of investor.
- The periodic interest payment method is there in the bullet bond scheme.
- The bullet bonds help the government entity to earn money for the public welfare projects.
- The repayment method of this type of bullet bonds is very easy. The entire principal amount is repaid back to the investor on the given maturity date.
- The maturity date of the bonds is the same, and therefore, the investor can invest any time to get returns.
- It can help the investors to plan their investments accordingly.
- The reinvestment of the principal amount is not possible in this case and therefore the risk is low in comparison to other bonds.
Some of the disadvantages of bullet bonds are:
- The investors will have to bear interest rate risk and therefore this type of bond can create confusion for the investors.
- The issuer of these bonds should be careful enough to understand the counterparty risk associated with the investment.
- It has also been seen that the bullet bonds give a very low coupon rate compared to the other bonds available in the market.
- It also lacks in embedded features therefore the investors are sometimes not interested to invest in such bonds.
- Bullet bonds are less flexible; therefore, it is always a risky investment.
- The investors of these bonds need to make some special capital provisions considering the risk associated with them.
The concept of bullet bonds is very old and traditional. Most of the investors are very actively investing their proceeds in these types of bonds. Considering the risk associated with the bonds, the investors are required to take some necessary steps to safeguard their interest. The government entities very commonly use the bonds to finance the public welfare projects. The maturity date of these bonds is the same, and therefore, most of the investor will seek this type of opportunity. It fetches a low coupon rate as compared to the other bonds in the market and therefore it can create confusion and the investor’s sentiment can get hurt. Hence, it is advisable to understand the entire repayment policy and the bond’s coupon rate before investing.
This is a guide to Bullet Bonds. Here we also discuss the definition and how does it work? Along with benefits and disadvantages. You may also have a look at the following articles to learn more –