What Is a Term Bond?
Term bonds are notes issued by companies to the public or investors with scheduled maturity dates. The term of the bond is the amount of time between bond issuance and bond maturity. On the maturity date of a term bond, the bond's face value, the principal amount, must be repaid to the bondholder.
Term bonds can be contrasted with serial bonds, which mature in installments over a period of time.
- Term bonds are bonds from a single issue that all mature on the same date.
- On the maturity date of term bonds, the face value (principal) must be repaid to the bondholders.
- Call provisions within term bonds stipulate characteristics where issuers can redeem bonds from investors before the maturity date.
- Unlike term bonds, serial bonds can have multiple and varying maturity dates.
How a Term Bond Works
Term bonds can have short- or long-term maturities; some may mature in a matter of weeks or months while others mature several years from the issue date.
Term bonds that have a call feature can be redeemed at an earlier stipulated date before the maturity date. A call feature, or call provision, is an agreement that bond issuers make with investors. This agreement is written in a document referred to as an indenture, which explains how and when the bond can be called, including the multiple call dates throughout the bond's life. Thus, the issuer of a callable bond can redeem the bond at a predetermined price, at specific times before the bond matures. The time from issuance to call date(s) represents the bond's active term. Some corporate and municipal bonds are examples of term bonds that have 10-year call features.
Types of Term Bonds
Term bonds may come with a sinking fund requirement, where the company sets aside an annual fund to repay the bond. Some companies also offer "secured term bonds" in which they promise to back their bond with company collateral or assets, in case they fail to repay the stated amount of the bond upon maturity. Other companies offer no such support. Their term bonds remain "unsecured," in which case investors must rely upon the company's credibility and history.
With registered term bonds, the issuer records details of the sale so that if the account is lost, the issuer can track the owner. Non-registered bonds are untraceable in that the company does not register the individuals to whom it sells its bonds.
Term bonds can be backed by specific collateral (secured term bonds), where the collateral is set aside to secure the bonds if they cannot be repaid at maturity.
Term Bonds vs. Serial Bonds
A term bond can be contrasted with a serial bond, which has various maturity schedules set at regular intervals until the issue is retired. A term bond refers to the issuance of bonds that are repaid at the same time. Term bonds can be short-term or long-term, with the latter having longer maturity dates than the former.
A serial bond structure is a common strategy for municipal revenue bonds because these bonds are issued for fee-generating projects built by states and cities. Assume, for example, that a city builds a sports stadium that is funded with parking fees, stadium concession income, and lease income. If the bond issuer believes that the facility can generate income consistently each year, it can structure the bond for serial maturity dates. As the total amount of bonds outstanding decreases, the future risk of the bond issue defaulting also declines.
Example of a Term Bond
As an example, let's assume a company issues a million dollars worth of bonds in January 2020, all of which are set to mature on the same date two years later. The investor can expect to receive repayment from these term bonds in January 2022.
Serial bonds, on the other hand, have different maturity dates and offer different interest rates. So, for instance, a company may issue a $1 million bond issue and allocate its repayment of $250,000 over five years.
Corporations tend to issue term bonds in which all of these debts mature simultaneously. Municipalities, on the other hand, prefer to combine serial and term issuances so that some debts mature in one block, while the payment of others is siphoned off.