What Is an Income Bond?
An income bond is a type of debt security in which only the face value of the bond is promised to be paid to the investor, with any coupon payments paid only if the issuing company has enough earnings to pay for the coupon payment.
In the context of corporate bankruptcy, an adjustment bond is a type of income bond.
Key Takeaways
- An income bond is a bond that only promises to repay the principal and does not guarantee any sort of interest or coupon.
- Instead, interest is paid to creditors as income comes in to the issuer, as defined by the specifications of the note.
- Income bonds are often issued during a corporate debt restructuring, for instance after a Chapter 11 bankruptcy filing.
Income Bond Explained
A traditional corporate bond is one that makes regular interest payments to bondholders and upon maturity, repays the principal investment. Bond investors expect to receive the stated coupon payments periodically and are exposed to a risk of default in the event that the company has solvency problems and is unable to fulfill its debt obligations.
Bond issuers that have a high level of default risk are usually given a low credit rating by a bond rating agency to reflect that its security issues have a high level of risk. Investors that purchase these high-risk bonds demand a high level of return as well to compensate them for lending their funds to the issuer.
There are some cases, however, when a bond issuer does not guarantee coupon payments. The face value upon maturity is guaranteed to be repaid, but the interest payments will only be paid depending on the earnings of the issuer over a period of time. The issuer is liable to pay the coupon payments only when it has income in its financial statements, making such debt issues advantageous to an issuing company that is trying to raise much-needed capital to grow or continue its operations.
Interest payments on an income bond, therefore, are not fixed but vary according to a certain level of earnings deemed sufficient by the company. Failure to pay interest does not result in default as would be the case with a traditional bond.
Debt Restructuring and Income Bonds
The income bond is a somewhat rare financial instrument that generally serves a corporate purpose similar to that of preferred shares. However, it’s different from preferred shares in that missed dividend payments for preferred shareholders are accumulated to subsequent periods until they are paid off.
Issuers are not obligated to pay or accumulate any unpaid interest on an income bond at any time in the future. Income bonds may be structured so that unpaid interest payments accumulate and become due upon maturity of the bond issue, but this is usually not the case; as such, it can be a useful tool to help a corporation avoid bankruptcy during poor financial health or ongoing reorganization.
Income bonds are typically issued either by companies with solvency problems in an attempt to quickly raise money to avoid bankruptcy or by failed companies in reorganization plans looking to maintain operations while in bankruptcy. To attract investors, the corporation would be willing to pay a much higher bond rate than the average market rate.
In the event of a Chapter 11 bankruptcy ruling, a company may issue income bonds, known as adjustment bonds, as part of its corporate debt restructuring to help the company deal with its financial difficulties. The terms of such a bond often include a provision that when a company generates positive earnings, it must pay interest. If revenues are negative, no interest payment is due.
FAQs
Debt Restructuring and Income Bonds
How do income bonds work? ›
Apply for Income Bonds
Interest is paid gross straight into your bank or building society account. Interest rates are variable. Anyone aged seven or over can invest in Income Bonds, either individually or jointly with one other person. They can also be bought by trustees for up to two personal beneficiaries.
Why would someone buy an income bond? ›
Why buy bonds? Bonds are issued by governments and corporations when they want to raise money. By buying a bond, you're giving the issuer a loan, and they agree to pay you back the face value of the loan on a specific date, and to pay you periodic interest payments along the way, usually twice a year.
How do fixed income bonds work? ›
Fixed-income securities provide a fixed interest payment regardless of where market interest rates move. An investor that purchased a bond paying 2% per year will lose out on income if market interest rates rise above that level and the investor's money is tied-up in the 2% bond.
How do bonds pay off debt? ›
In exchange for the capital, the company pays an interest coupon, which is the annual interest rate paid on a bond expressed as a percentage of the face value. The company pays the interest at predetermined intervals (usually annually or semiannually) and returns the principal on the maturity date, ending the loan.
How safe are income bonds? ›
Although they may not necessarily provide the biggest returns, bonds are considered a reliable investment tool. That's because they are known to provide regular income. But they are also considered to be a stable and sound way to invest your money.
How do I cash in income bonds? ›
You can also cash in Income Bonds online without having to create an account. You'll need your NS&I or account number and bank account details to hand. Or send us a withdrawal form.
How often do income bonds pay? ›
I savings bonds earn interest monthly. Interest is compounded semiannually, meaning that every 6 months we apply the bond's interest rate to a new principal value. The new principal is the sum of the prior principal and the interest earned in the previous 6 months.
Are high income bonds risky? ›
What are the risks? Compared to investment grade corporate and sovereign bonds, high yield bonds are more volatile with higher default risk among underlying issuers. In times of economic stress, defaults may spike, making the asset class more sensitive to the economic outlook than other sectors of the bond market.
Why is bond not a good investment? ›
There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall.
Most are unsecured promises to repay the principal at a predetermined future date, although some bonds may be secured by a first mortgage or other assets. The issuing company also agrees to pay interest to compensate investors for lending their money.
Are bonds safe if the market crashes? ›
There is nothing that will definitely go up if the stock market crashes. Interest bearing investments such as money market funds will continue to earn interest. Bonds may hold their value or increase, and individual bonds including Treasury's will continue to earn interest.
Which bonds give a monthly income? ›
Monthly interest fixed rate bonds pay interest monthly on a lump sum deposited for a fixed term. These bonds can be one of the best options if you are looking for an account which will provide you with a source of regular monthly extra income.
Can you withdraw money from a bond? ›
You can withdraw up to 5% each year of the amount you have paid into your bond without paying any immediate tax. This 5% limit is cumulative so any unused part can be carried forward to future years (the total can't be more than the amount paid in). If you take more than this you could create a tax liability.
What are the cons of bonds? ›
Cons of Buying Bonds
- Values Drop When Interest Rates Rise. You can buy bonds when they're first issued or purchase existing bonds from bondholders on the secondary market. ...
- Yields Might Not Keep Up With Inflation. ...
- Some Bonds Can Be Called Early.
You can get your cash for an EE or I savings bond any time after you have owned it for 1 year. However, the longer you hold the bond, the more it earns for you (for up to 30 years for an EE or I bond). Also, if you cash in the bond in less than 5 years, you lose the last 3 months of interest.
How does a $1000 bond work? ›
For a $1,000 par, 10% annual coupon bond, the issuer will pay the bondholder $100 each year.5 If prevailing market interest rates are also 10% at the time that this bond is issued, an investor would be indifferent to investing in the corporate bond or the government bond since both would return $100.
How often do income bonds pay interest? ›
You can buy paper I bonds with your IRS tax refund. How does an I bond earn interest? I savings bonds earn interest monthly. Interest is compounded semiannually, meaning that every 6 months we apply the bond's interest rate to a new principal value.
What bonds give you monthly income? ›
Monthly interest fixed rate bonds pay interest monthly on a lump sum deposited for a fixed term. These bonds can be one of the best options if you are looking for an account which will provide you with a source of regular monthly extra income.
How much income do bonds pay? ›
A bond is a loan to a company or government that pays investors a fixed rate of return. The borrower uses the money to fund its operations, and the investor receives interest on the investment. The market value of a bond can change over time. Long-term government bonds historically earn an average of 5% annual returns.
