Balloon Maturity: What It Is, How It Works

The investor can expect to receive repayment from these term bonds in January 2022. 1The series of steps shown here is also used when a bond is issued at a premium above face value. If the effective rate negotiated by the parties is below the stated cash rate, the amount paid for the bond (the present value) will be above face value rather than below. In effect, the high rate of cash interest makes the bond more valuable.

• The maturity date differentiation may be the defining difference, however, it’s wise to understand what both term and serial bonds are, and how they work.
• Standard & Poor’s and Moody’s Investor Services both provide bond ratings that assess the ability of a bond issuer to repay principal and interest payments on time.
• Investors are bound to rely upon the credibility of the company, although it does represent a greater risk in the event of business failure.
• On the maturity date of a term bond, the bond’s face value, the principal amount, must be repaid to the bondholder.

The company must pay $20,000 every year toward the face value of various serial bonds. It also must pay coupon payments that decline each year, as the company retires more principal. However, it owes an additional $100,000 balloon payment in the final year.

Bond valuation

However, the company may be confident in 10 or 15 years, when the loan term ends, it will have grown exponentially and been able to meet the balloon payment. The nature of the issuer will affect the security (certainty of receiving the contracted payments) offered by the bond, and sometimes the tax treatment. Term bonds sometimes carry a call feature that allows the issuer to redeem the bonds prior to their maturity date. If the indenture carries this provision, it will include a schedule of redemption dates and prices. Serial bonds are usually quoted using their yield, while term bonds are quoted using their price.

• Thomas’ experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning.
• If you’re not familiar with the differences because the average person doesn’t either.
• Serial bonds are paid off periodically rather than at one final maturity date.
• However, balloon maturity has also come to refer to large final payments to repay mortgages, commercial loans, and other types of debts.

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. Certain provisions within some term bonds provide the issuers of the bonds with the option of redeeming the bonds from the investors before the maturity date. Term bonds are notes issued by companies to the public or investors with scheduled maturity dates.

A typical offering consists of as many as 20 or more different maturities. When borrowers issue serial bonds, different interest rates are attached to bonds maturing at serial maturities. Although serial bonds cannot necessarily be retired at the discretion of the issuer, the issuer may be permitted, on some occasions, to retire the debt at the same time. Serial bonds are distinguished from term bonds in which the bonds in an issue have the same maturity date.

Guest Author James Chen explains that the structure of the serial bonds mature at regular intervals until all the purchased bonds have matured. The total bond issue is purchased on the same date with offset dates for maturity as stated in the agreement/prospectus signed by the issuer and also the purchaser. Accounting Coach provides reliable information about term bonds. Based on their website, term bonds come due or mature on a single date. Serial bonds differ in that they come with various maturity dates which are spread out over a period of several years.

Only a portion of the loan’s principal balance is amortized over the term. At the end of the term, the remaining balance is due as a final repayment. Another way is to buy them through a broker or an investment company. Finally, you can also invest in serial bonds through a mutual fund or an exchange-traded fund.

Redeemable vs. Irredeemable Debentures: Financial Terms

Issuing long-term bonds represents an important source of financing for many large companies. Bonds payable is used to categorize the payments due when a company issues an indenture, or enters into a contract that represents a promise to pay. Most government bonds are denominated in units of $1000 in the United States, or in units of £100 in the United Kingdom. Hence, a deep discount US bond, selling at a price of 75.26, indicates a selling price of $752.60 per bond sold.

The conditions applying to the bond

Chet Wang is a registered municipal advisor with an exclusive focus on California education municipal bonds. He has provided financial advisory and investment banking services to California school and community college districts since 2005. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. For the Smith Corporation serial bond described above, the following steps are required.

Suppose that the city of San Francisco issues $5 million of serial bonds whose terms require that $500,000 of the bonds are repaid every 5 years, beginning 5 years after the date of issue. Serial bonds have principal payments that are required at specific intervals. Term bonds can be contrasted with serial bonds, which mature in installments over a period of time. A callable bond can be redeemed by the issuer at a price that has been predetermined and agreed upon by both the issuer and the purchaser. The bond can be called at the times specified in the indenture before the bond matures.

Understanding Term Bonds

As each serial bond matures, the issuer must replace it with a new bond to maintain the cash flow. If interest rates have risen since the initial issuance, the issuer may find it more expensive to refinance the bonds, which could lead to higher borrowing costs. Additionally, the frequency of principal repayments can result in reinvestment risk for investors, as they may struggle to find suitable investment opportunities for their cash inflows. The issuer of a serial bond may lessen the dollar amount of outstanding bonds to reduce the risk of missed principal repayments or default on the bond issue. Serial bonds are common for municipal revenue bonds to finance projects undertaken by cities and states.

Types of Term Bonds

In some cases, both members of the public and banks may bid for bonds. Serial bonds are bonds which do not mature or us recession on the horizon when experts think it could hit come due on a single date. Instead, serial bonds have maturity dates which are staggered over several or many years.

If the borrower cannot make the final balloon payment, they may refinance their mortgage or even sell their house to settle the balance on the debt. Bond markets, unlike stock or share markets, sometimes do not have a centralized exchange or trading system. Rather, in most developed bond markets such as the U.S., Japan and western Europe, bonds trade in decentralized, dealer-based over-the-counter markets.

In addition, the unpaid face value for Year One is $1 million so the 5 percent stated rate necessitates a $50,000 year-end interest payment. Following the first principal payment, the remaining face value is only $750,000 throughout the second year. Thus, the interest payment at the end of that period falls to $37,500 ($750,000 × 5 percent). Based on the contract, the cash flows required by this bond are as follows. For example, an issuer may choose to release 500 bonds which mature gradually, with payments due annually for five years.

When you invest in a term bond, you lend money to the issuer for a fixed period of time, which is typically between 5 and 30 years. The issuer pays you regular interest, known as coupon payments, throughout the term, and at the end of the term, you receive the face value of the bond. Term bonds are generally considered less risky than serial bonds because they have a longer duration and are not subject to refinancing risk. In a sinking fund, the issuer makes periodic payment to the bond issue’s trustee, and the trustee purchases bonds in the open market and retires the bonds. The trustee represents the interests of the bondholders and must use the sinking fund payments to buy bonds and retire them.

Some bond agreements may have multiple call dates throughout the life of the bond. In contrast, a traditional five-year bond would pay interest for five years without making a single principle payment. Then at the end of the term, the bond issuer would have to repay the entire principle in one payment.

One reason is that serial bonds often have higher interest payments than term bonds. Another reason is that serial bonds can be more flexible since they don’t have a set maturity date. 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.