What Is a Bullet Bond?
A bullet bond is a debt investment whose entire principal value is paid in one lump sum on its maturity date, rather than amortized over its lifetime. Bullet bonds cannot be redeemed early by their issuer, which means they are non-callable.
Bullet bonds issued by stable governments typically pay a relatively low rate of interest due to the negligible risk that the lender will default on that lump sumpayment. A corporate bullet bond may have to pay a higher interest rate if the corporation has a less-than-stellar credit rating.
In any case, bullet bonds generally pay less than comparable callable bonds because the bullet bond does not give the lender the option of buying it back if interest rates change.
- A bullet bond is a non-callable bond in which the principal is repaid as a lump sum when the bond matures.
- Both governments and corporations issue bullet bonds in a variety of maturities.
- The issuer of a bullet bond accepts the risk that interest rates during the life of the bond will decrease, rendering its rate of return relatively costly.
Understanding Bullet Bonds
Both corporations and governments issue bullet bonds in a variety of maturities, from short- to long-term. A portfolio made up of bullet bonds is generally referred to as a bullet portfolio.
A bullet bond is generally considered riskier to its issuer than an amortizing bond because it obliges the issuer to repay the entire amount on a single date rather than in a series of smaller repayments over time.
As a result, issuers who are relatively new to the market or who have less than excellent credit ratings may attract more investors with an amortizing bond than with a bullet bond.
Typically, bullet bonds are more expensive for the investor to purchase compared to an equivalent callable bond since the investor is protected against a bond call if interest rates fall.
A "bullet" is a one-time lump-sum repayment of an outstanding loan made by the borrower.
Bullet Bonds vs. Amortizing Bonds
Bullet bonds differ from amortizing bonds in their method of payment.
Amortized bonds are repaid in regular, scheduled payments that include both interest and part of the principal. In this way, the loan is entirely repaid at its maturity date.
In contrast, bullet bonds may require small, interest-only payments, or no payments at all, until the maturity date. On that date, the entire loan plus any remaining accrued interest must be repaid.
Example of a Bullet Bond
Pricing a bullet bond is straightforward. First, the total payments for each period must be calculated and then discounted to a present value using the following formula:
Present Value (PV) = Pmt / (1 + (r / 2)) ^ (p)
- Pmt = total payment for the period
- r = bond yield
- p = payment period
For example, imagine a bond with a par value of $1,000. Its yield is 5%, its coupon rate is 3%, and the bond pays the coupon twice per year over a period of five years.
Given this information, there are nine periods for which a $15 coupon payment is made, and one period (the last one) for which a $15 coupon payment is made and the $1,000 principal is repaid.
Using the formula, the payments will be as follows:
- Period 1: PV = $15 / (1 + (5% / 2)) ^ (1) = $14.63
- Period 2: PV = $15 / (1 + (5% / 2)) ^ (2) = $14.28
- Period 3: PV = $15 / (1 + (5% / 2)) ^ (3) = $13.93
- Period 4: PV = $15 / (1 + (5% / 2)) ^ (4) = $13.59
- Period 5: PV = $15 / (1 + (5% / 2)) ^ (5) = $13.26
- Period 6: PV = $15 / (1 + (5% / 2)) ^ (6) = $12.93
- Period 7: PV = $15 / (1 + (5% / 2)) ^ (7) = $12.62
- Period 8: PV = $15 / (1 + (5% / 2)) ^ (8) = $12.31
- Period 9: PV = $15 / (1 + (5% / 2)) ^ (9) = $12.01
- Period 10: PV = $1,015 / (1 + (5% / 2)) ^ (10) = $792.92
These 10 present values equal $912.48, which is the price of the bond.