What Is a Straight bond?
A straight bond pays interest on a frequent basis and returns the original investment principal when the bond matures. In comparison to other bonds with integrated alternatives, a straight bond has no particular features. Straight bonds include government-issued Treasury bonds. A straight bond is also known as a bullet bond or a plain vanilla bond.
Further Key Takeaways on Straight Bonds Definition
- The most fundamental of debt investments is a straight bond. It’s also known as a plain vanilla bond because it lacks the other elements seen in other types of bonds. The features of all other bond types are variations or additions to those of ordinary straight bonds. Some bonds, for example, can be converted into common stock shares, while others can be called or redeemed before their maturity dates. Convertible, callable, and puttable bonds are structured like regular bonds but with a call option or warrant.
- Default risk, which is the risk that the company will go bankrupt and cease to honour its debt commitments, and interest rate risk, which is the risk that rate fluctuations would affect bond prices in the secondary market, are both present in all bonds.
- Consistent coupon payments, face value or par value, purchase value, and specified maturity date are all basic qualities of a straight bond. A straight bondholder anticipates receiving periodic interest payments on the bond, known as coupons until the bond expires. The principal investment is reimbursed to the investor at the maturity date.
- The bond’s purchasing price determines the return on principal. If the bond was bought at par, the bondholder gets the par value at maturity. If the bond was bought at a premium to par, the investor will get a lower par value than his or her initial capital investment. Finally, a bond bought at a discount to par means the investor will get a higher return on his or her initial investment when the bond matures.
Straight Bonds – An Example
Consider a Rs 1,000 face value discount bond issued by a corporation. The bond’s redemption date is set for 10 years from the issuance date, and the coupon rate is set at 5%, according to the trust indenture. Because the coupon is paid once a year, bondholders will earn 5% x Rs 1,000 face value = Rs 50 every year for the next ten years. The last coupon payment is made on the maturity date, together with the redemption amount of the bond’s face value.
A bondholder will receive Rs 1,000 face value on the maturity date because the bond was issued and purchased for a discount value of Rs 925. In this situation, an investor who wishes to compute the bond’s yield can use the present yield, which is calculated by dividing the annual coupon by the bond price. In the example, the current yield is Rs 50/Rs 925 = 5.41 percent.
How Does It Work?
- Bonds are used by corporations and large companies to raise finance. They are loan products that help borrowers minimise their total cost of capital. Bonds offer lower interest rates than bank loans, which they can take advantage of. The most basic form of these financial instruments is a straight bond, which is issued with only the most basic attributes.
- It offers coupon payments as well as the prospect of a principal repayment at maturity. It excludes any covenants with unique features, such as the call feature, which allows the bond to be redeemed before maturity. The straightforward structure makes it easy for investors and borrowers to commit their funds.
- Bonds are debt securities that are advantageous to both investors and debtors. Borrowers can lower their cost of capital by using low-cost bond financing. Bond coupon payments provide investors with continuous and predictable income. In the simplest terms, it gives investors and borrowers that flexibility.
Things To Consider
- Straight bonds provide investors with a consistent stream of income. The interest rate, coupon payment interval, and maturity repayment are the most important elements of this bond. This bond has no unique characteristics or covenants.
- They often lack the flexibility that investors seek because they do not provide any particular features. Borrowers typically sell straight bonds at a discount to par value on the market as a kind of compensation. It entices investors to purchase these bonds at a discount to par value and then sell them at a higher price in the market. Some investors hold these bonds until they are due to be redeemed at face value. Their main goal is to get regular coupon payments from a straight bond.
- Investors profit from straight bonds by receiving coupon payments when the principal is repaid. The income portion of this bond is fixed once the interest rate and payment intervals are determined. Investors can profit by selling the bond at a higher price than when they bought it or by holding it until it matures. This, however, is dependent on the bond’s purchase price. If the investors purchase the bond for more than its face value, they will have to redeem it at a loss when it matures. If they purchase the bond at a discount, they will be able to redeem it at a profit when it matures.
Benefits of a Straight Bond
Straight bonds are the most basic type of financial instrument, yet they have various advantages.
-Through monthly coupon payments, investors can earn a steady income from a straight bond.
-Low-cost straight bonds can help borrowers minimise their total cost of financing.
-These relationships are simpler to assess.
-These bonds are extremely liquid, making them excellent marketable instruments.
-These bonds can help investors reduce the risk of their investment portfolio.
Drawbacks of a Straight Bond
Straight bonds, on the other hand, can have significant drawbacks.
-Straight bonds, like any other sort of bond, are subject to interest rate and default risk.
-Volatility is also a danger with these bonds.
-There are no special features embedded in these bonds to entice investors.
-Interest rate risk has an impact on the secondary market pricing of these bonds.
A straight bond has all of the characteristics of a debt instrument. It provides investors with regular coupon payments as well as principal repayment. There are no particular features or stipulations in a straight bond. It carries the same interest rate and default risk as any other bond.