| DEFINITION: A serial bond is a debt security that is payable at various intervals throughout its term rather than only at a specific maturity date, resulting in the issuer paying less interest. |
In the case of municipalities…
Normally when government entities issue bonds, they have a set maturity date at which point the bond issuer will repay the full face value of the bonds, with regular interest payments until then. But serial bonds are structured in a way that allows an issuer to pay them back at regular intervals over the bond term.
Because the bond principal is gradually reduced, so is the amount the issuer must pay its investors in interest.
Serial bonds are often used by local governments for projects that will create a stream of income since they can use that income to repay a portion of the bond.
| EXAMPLE: Suppose a local government issued $10 million in serial bonds to fund an infrastructure project. In the first five years, the government entity makes interest payments to its investors, just as it would on any other bond. But starting in the sixth year, the government repays $2 million of the bond’s face value each year. Because the bond principal is reduced each year, so is the interest the government must pay. For example, the government only pays interest on $8 million in the seventh year, $6 million in the eighth year, and so on. |
What’s important here?
Serial bonds can benefit both issuers and investors. Government entities appreciate their ability to repay the bonds at specific intervals, rather than simply at the end of the bond term. Not only does this help them to manage their cash flow, but it also helps them save money on interest since the bond principal is gradually reduced.
For investors, serial bonds can be beneficial because they’ll receive a portion of their investment early and on a set schedule. In fact, serial bonds resemble the bond ladders that many investors create for themselves.