09 Aug Serial Bonds
What are Serial Bonds?
Definition: The amount raised by the issue of a serial bond is repaid in portions on different dates. Bondholders get their principal amount back over an extended period instead of receiving the entire sum on one date.
What does Serial Bond mean?
Serial bonds are a good option for raising money for projects that generate returns on a consistent basis. The excess cash that a new venture provides could be used to repay bondholders. This serves several purposes. The bond issuer could minimize the interest cost of the project by reducing the principal outstanding on the bonds in a gradual manner.
Another advantage that a serial bond offers is that it lowers the level of risk that a bondholder is exposed to. The principal amount of a traditional bond would be repaid on the day the bond matures. If the bond issuer defaults on the repayment of a traditional bond, the entire sum invested by the bondholder could be at risk. However, in a serial bond, exposure of the bondholder comes down with each repayment.
Municipal bond issuers commonly issue serial bonds. The project’s cash flow is used to retire the outstanding bond amount gradually. A corporation could also issue a serial bond if the project that it is raising money for can provide a consistent cash flow that could be used to make repayments.
Example of Serial Bonds
ViaConnect Inc., a corporation that builds toll roads and bridges, decides to raise $50 million by issuing a serial bond. The terms of the issue are:
⇨ Interest of 6% per year will be paid on outstanding amounts.
⇨ In the first eight years after the bond issue, only interest payments will be made.
⇨ Subsequently, in year nine, repayment of the principal amount will commence. A sum of $10 million will be repaid to bondholders every year from year nine to year 13. The final repayment will be made in year 13.
The company expects the revenues from its toll collections to allow it to repay bondholders.
A serial bond matures in portions instead of on a single date. It is a good option for issuers who expect their projects to generate cash flows on a regular basis. These amounts can be used to repay bondholders.