An Amortized Bond is a bond where the principal amount, also known as the face value, is paid back over the life of the bond in incremental payments.
Amortized Bond Explained
Investing in bonds? You’ll often hear the term Amortized Bond. Simply put, this is a bond where the principal amount, also known as the face value, is paid back over the life of the bond in incremental payments.
Unlike a bullet bond, where you get your principal back at the end of the term in a lump sum, an amortized bond repays portions of the principal along with interest payments throughout its lifespan.
This reduces the risk for investors as they recoup part of their investment gradually, rather than waiting for the maturity date.
So, why does this matter? Well, the amortization aspect significantly impacts both the risk profile and the interest income of the bond.
You’re essentially hedging against the risk of default by the issuer, as your exposure decreases over time. This means less worry about whether you’ll get your full investment back.
- With the principal being returned gradually, there’s a reduced risk of losing your entire investment in case of default.
- Amortized bonds provide a consistent cash flow, which is beneficial for investors looking for regular income.
- Since you get portions of your principal back over time, you can reinvest it, reducing reinvestment risk.
An Example Of An Amortized Bond
Consider a 5-year amortized bond with a face value of $1,000 and an annual interest rate of 5%. Every year, you’ll not only receive interest payments but also a portion of the $1,000 principal.
By the end of the five years, you would have received your entire principal back along with the interest payments.
How are the payments calculated in amortized bonds?
Payments are calculated to include both principal and interest, often using a fixed amortization schedule.
Can amortized bonds be callable?
Technically, yes, but it’s less common due to the repayment structure.
What are the tax implications?
Interest is taxable, and the principal repayments have to be accounted for in your investment records.