Most popular bond types.

  • Callable bonds
    A callable (or redeemable) bond gives the issuer the right to buy back all or some of the issue prior to the stated maturity date. The bonds are redeemable by the issuer at a specified price (call price), which may be the par value of the bond or a price higher than the par value. Callable bonds are particularly popular with corporate and municipal bond issues in the US. The most common scenario occurs when market interest rates fall below the interest rate on the bond. In such a situation, the issuer can benefit by redeeming the bond and issuing another bond at a lower interest rate (refunding). From an investor’s point of view, this may result in the surrendering of a high-coupon issue and reinvestment in a bond issue at a lower, less attractive interest rate. To compensate the investor, yields on callable bonds are generally higher than those on equivalent non-callable issues.
    Call features may provide for the following:

    • Optional redemption
      The issuer has the right, but no the obligation, to redeem the issue after a specified period of time.
    • Extraordinary redemption
      The issuer has the right to redeem the issue if certain specified events occur (for example, destruction or damage to a facility/project that was being financed by the bond issue). If the specified event occurs, redemption may be mandatory (extraordinary mandatory redemption) or at the issuer’s choice (extraordinary optional redemption).
    • Sinking fund redemption
      The issuer is required to redeem some bonds on a periodic basis to satisfy a sinking fund provision.
  • Floating rate notes (floaters)
    Floating rate notes (FRNs) are bonds with coupon rates that are reset periodically, based on a margin or spread over a reference rate. Popular reference rates include 3- or 6-month Libor (London Interbank Offered Rate), Euribor (Euro Interbank Offered Rate), and yields on short-term government securities. Typical interest reset periods are therefore every quarter or every six months.
    Some borrowers have issued bonds that combine the features of both fixed and floating rate issues. For example, the bond may have a fixed rate for the first year following its issue and then revert to a floating rate for the remainder of its term.

  • Zero-coupon bonds (zeros)
    A zero-coupon bond is a bond with no coupon rate. Investors in these securities do not receive any interest payments during the life of the bond. Instead, the bonds provide a return to investors by being sold at a discount to their redemption (par) value. At maturity, the holder receives the full redemption amount. This amount includes the initial investment amount plus the accrued interest over the life of the bond.

  • Inflation-linked bonds (linkers)
    Inflation- or index-linked securities (linkers) provide protection to investors against inflation. Linkers pay a fixed coupon plus an amount to compensate for inflation. The fixed coupon represents the real yield of the security, and the inflation amount is tied to a relevant price index.

  • High yield (junk) bonds
    High yield bonds are securities rated below investment grade, that is, rated below Baa3 (Moody’s) or BBB- (Standard & Poor’s). This form of debt carries a higher risk of default compared with other forms of debt, but compensates investors by paying a higher yield.

  • Covered bonds
    Covered bonds are bonds collateralized by commercial and/or residential mortgages and/or public sector assets. They represent the senior debt instrument of the issuer, with the bondholder having full recourse to a pool of assets ring-fenced from the issuer’s other assets. Covered bonds are similar in some ways to asset-backed securities; however, the pool of assets is not placed in a special purpose vehicle (SPV) but instead remains on the balance sheet of the issuer. Segregation of the pool assets has to be undisputed, otherwise a high rating for the pool may not be achieved. The credit strength of the issuer is the main driver.

  • Stepped-coupon bonds
    Stepped-coupon bonds are a variation of straight fixed rate bonds that have been issued by some borrowers. These are securities whose coupon rate increases during the life of the bond.
    For example, a 5-year ‘step-up’ bond might be issued with a coupon of 5% for the first year, 5.5% for the second year, 6% for the third year, and so on. After an initial non-callable period, step-up bonds are callable at each step-up date and are therefore attractive to issuers with a strongly held view that interest rates will fall – a replacement bond can then be issued at a lower rate.

  • Dual currency bonds
    Dual currency bonds are quite common in the international bond (Eurobond) market. They are bonds where coupon payments can be made in one currency and principal payments in another currency.

  • Securitized bonds
    Securitization is the term applied to the pooling and packaging of similar loans into marketable securities (such as bonds) to be sold to investors.
    A mortgage-backed security (MBS) represents a securitized interest in a pool of mortgages (usually residential mortgages), while an asset-backed security (ABS) represents a securitized interest in non-mortgage financial assets, such as credit card balances, car loans, equipment lease receivables, and so on.

  • Hybrid securities (hybrids)
    A hybrid is a security that combines the characteristics of two or more financial instruments, generally debt and equity characteristics.
    An example of a hybrid is the convertible bond (convertible), which is a bond that, at an agreed future date and price, can be converted into other securities (usually the common stock of the issuing company). The decision to convert is at the discretion of the investor.