Types of Bonds
Kyle Ashcraft, CPA · 2019 CPA Exam Scores · 95 FAR · 98 BEC · 91 REG · 90 AUD
Bonds aren't all the same instrument with different names slapped on. They're distinguished by their collateral, their priority in bankruptcy, how they're repaid, and what options are built into them for either side. Here's a rundown of the most commonly tested types.
What's the difference between secured and unsecured debt?
Secured debt is backed by collateral — an asset the lender has the right to seize if the borrower doesn't pay. Unsecured debt has no collateral backing it. Unsecured bonds are also called debentures.
What is a subordinated debenture?
A subordinated debenture is an unsecured bond where the holder ranks lower on the priority list than other creditors if the company goes bankrupt — "subordinate" means lower in rank.
What is a junk bond?
A junk bond is issued by a company in a weak financial position. It pays a high interest rate to compensate investors for the risk, but repayment isn't guaranteed.
What is an income bond?
An income bond only obligates the company to make interest payments once its income reaches a certain level — if the company doesn't hit that threshold, it doesn't have to pay.
What is a zero-coupon bond?
A zero-coupon bond pays no periodic interest at all. Instead, it's issued at a discount to its face value, and that discount — the gap between what you pay now and what you collect at maturity — is the investor's entire return.
What's the difference between a term bond and a serial bond?
A term bond is the most common structure: the company repays the full principal in one lump sum at the end of the bond's life. A serial bond instead repays principal gradually, in installments, throughout the bond's life.
What is a convertible bond?
A convertible bond gives its owner the option to convert the bond into shares of common stock, instead of collecting cash at maturity.
What's the difference between a puttable bond and a callable bond?
A puttable bond gives the bondholder the right to demand early repayment from the issuer. A callable bond — also called a redeemable bond — gives the issuer the right to pay the bond off early instead.
Every bond feature answers one of a few questions: how much risk is the holder taking (secured vs. unsecured, subordinated, junk), how is it repaid (term vs. serial), how does interest work (income, zero-coupon), and who holds the option to end it early (puttable vs. callable/redeemable, or convertible into stock).
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Kyle Ashcraft, CPA scored 90 or above on every section of the CPA exam in 2019, including a 98 on BEC. He is the founder and sole instructor of Maxwell CPA Review, a complete CPA review course covering all six sections, where he creates every lecture, textbook and study outline himself.