The typical investment bond pays a fixed rate of interest for a period of years and on the maturity date the full principal value is paid off by the issuer. The less common serial bond type spreads the repayment of principal over a period of years. A serial bond issue provides investment flexibility for investors.
A serial bond is issued with a partial principal redemption scheduled every year. For example, a $100 million serial bond issue could be scheduled to have $5 million worth of bonds paid off every year for the next 20 years. For the issuer, the outstanding debt of the bond is paid off in stages each year rather than making the entire $100 million principal payment at the end of 20 years. An investor gets to select the maturity year for which she wants to own bonds. Some investors may be interested in the long-term section, maturing in 20 years. Other investors could be happy to tie their money up for just four or five years.
Rates of Return
The interest rates on a serial bond can be set differently for each year of principal redemption. The shorter-term sections of the serial bond may pay lower interest rates, and the rate could be higher for the longer-term redemptions. A serial bond issue can save on the total interest payments for the issuer compared to paying the same rate for many years on a longer, single-term bond. Serial bonds are quoted by rate and year of redemption. This is in contrast to single-term bonds, which are quoted by bond price and for which the yield is then computed from the price.
Serial Bond Issuers
Serial bonds are primarily used by municipal bond issuers, but corporations sometimes use serial bonds to meet a certain financing need. A serial bond may be used to fund a project where the annual cash flow can be accurately forecast and enough money will come in to pay both the interest on the outstanding portions of the serial bond and the principal amount to be retired each year.
Investing in Serial Bonds
Municipal serial bonds provide a range of options for investors. Since it is sometimes hard to sell municipal bonds at a competitive price in the secondary market, investing in a serial bond allows you to tailor bond maturities to fit specific financial goals. The interest earned from municipal bonds is exempt from federal income tax. If the bonds are from an issuer located in your home state, the interest will be exempt from state income tax as well.