What Is a Straight Bond?
A straight bond is a bond that pays interest at regular intervals, and at maturity pays back the principal that was originally invested. A straight bond has no special features compared to other bonds with embedded options. U.S. Treasury bonds issued by the government are examples of straight bonds.
A straight bond is also called a plain vanilla bond or a bullet bond.
- A straight bond is a plain vanilla bond that obliges the issuer to regular, fixed interest as well as principal repayment upon maturity.
- Also known as a bullet bond, these issues do not have any special features, embedded options, floating interest rates, or exotic covenants.
- This makes pricing straight bonds easy and straightforward, but these bonds are still subject to interest rate and default risk that can harm investors.
Straight Bonds Explained
A straight bond is the most basic of debt investments. It is also known as a plain vanilla bond because it has no additional features that other types of bonds might have. All other bond types are variations of or additions to standard straight bond features. For example, some bonds can be converted into shares of common stock and others can be called or redeemed before their maturity dates. Special bonds such as convertible, callable, and puttable bonds are structured as straight bonds plus a call option or warrant.
As with all bonds there is default risk, which is the risk that the company could go bankrupt and no longer honor its debt obligations, as well as interest rate risk as rate changes affect bond prices in the secondary market.
The standard features of a straight bond include constant coupon payments, face value or par value, purchase value, and a fixed maturity date. A straight bondholder expects to receive periodic interest payments, known as coupons, on the bond until the bond matures. At maturity date, the principal investment is repaid to the investor. The return on principal depends on the price that the bond was purchased for. If the bond was purchased at par, the bondholder receives the par value at maturity. If the bond was purchased at a premium to par, the investor will receive a par amount less than his or her initial capital investment. Finally, a bond acquired at a discount to par means that the investor’s repayment at maturity will be higher than his or her initial investment.
Example of Straight Bonds
For example, let’s look at a discount bond with a face value of $1,000 issued by a corporation. The redemption date for the bond is scheduled for 10 years from the issue date and the coupon rate, as noted in the trust indenture, is fixed at 5%. The coupon is to be paid annually, therefore, the bondholders will receive 5% x $1,000 face value = $50 every year for ten years. On the maturity date, the last coupon payment is made plus the redemption amount of the bond’s face value. Since the bond was issued and purchased for a discount value of $925, a bondholder will receive $1,000 face value on the maturity date. In this case, an investor that wants to measure the yield of this bond can calculate the current yield, which divides the annual coupon by the bond price. The current yield in our example is $50/$925 = 5.41%