Deferred Interest Bonds: Definition, Types, and Considerations
AN
Summary:
Deferred interest bonds, known as deferred coupon bonds, pay accumulated interest as a lump sum at maturity rather than through periodic payments. This article explores the mechanics of deferred interest bonds, including types such as zero-coupon bonds and toggle notes, and considers their suitability for investors seeking higher returns while understanding associated risks.
Compare Investment Advisors
Compare the services, fees, and features of the leading investment advisors. Find the best firm for your portfolio.
Understanding deferred interest bonds
A deferred interest bond, or deferred coupon bond, deviates from traditional bonds by deferring interest payments until maturity. Instead of receiving periodic coupon payments, investors receive a single payment of both principal and accrued interest at the bond’s maturity date.
These bonds typically debut at a discounted price due to the absence of periodic interest payments. Investors, aware of this structure, purchase them for the potential of higher returns at maturity.
Types of deferred interest bonds
Zero-coupon bonds
Zero-coupon bonds, often termed Z-bonds, represent a prominent form of deferred interest bonds. Unlike conventional bonds, zero-coupon bonds do not make periodic interest payments. Instead, investors purchase them at a discounted rate and receive the face value at maturity, reflecting the accrued interest.
Toggle notes
Toggle notes provide another avenue for managing cash flow, particularly for issuing firms. By deferring interest payments for a specified period, toggle notes enable borrowers to navigate temporary financial challenges without defaulting on debt obligations. This arrangement often involves agreeing to pay a higher coupon rate in the future.
Frequently asked questions
How do deferred interest bonds differ from traditional bonds?
Deferred interest bonds postpone interest payments until maturity, whereas traditional bonds pay periodic interest to investors.
Are deferred interest bonds suitable for risk-averse investors?
Deferred interest bonds may not be ideal for risk-averse investors due to their reliance on a single lump-sum payment at maturity, potentially exposing them to greater risk.
Can deferred interest bonds be traded on secondary markets?
Yes, deferred interest bonds can typically be traded on secondary markets, providing investors with liquidity options before maturity.
Key takeaways
- Deferred interest bonds offer the potential for higher returns but involve unique risks compared to traditional bonds.
- Zero-coupon bonds and toggle notes are common types of deferred interest bonds, each with its own features and considerations.
- Investors should carefully assess their risk tolerance and investment objectives before considering deferred interest bonds.
Share this post: