Deferred Interest Bonds –How High Yield Bonds Work
When you purchase a bond, in most cases, you will receive interim or coupon payments in between the point when you purchase it and the time frame in which it matures. However, there are other types of bonds that defer these interest payments, known as deferred interest bonds. These allow the interest to accrue over the entire term of the bond, and then pay you back the lump sum interest payment at the time of this maturity along with the principal amount. For example, if you purchase a one year deferred interest bond with a value of $1,000, at an annual yield of 10%, at the end of your one year term you would receive $1,100 back.
As a result, deferred interest bonds can be a good option for those who are looking at long term investments, or want to use their bonds as a type of savings account alternative. Because there are no coupon payments, however, this is not a good investment option for those who want dividends or earnings on a regular basis. These types of bonds also usually offer a higher interest rate than other investment grade bonds. Some issuers of these are also called high yield bonds or junk bonds, depending on the terms and conditions of the bond and the institution offering it.
Some issuers of deferred interest bonds, for example, are companies which have bad credit or are in poor financial shape at the moment, but expect that their fortunes will turn around in the near future. As a result, they cannot afford to pay coupon payments to those who purchase their bonds, but they make up for this with a higher interest rate for the future, which they hope to pay back in full at the end of the term. This time period can range anywhere from three to seven years in many cases, and is usually for five years at a time.
In addition to deferred interest bonds, another investment option of this nature is a pay in kind debenture. These give the issuer the option of paying a single interest payment or a cash interest payment. It’s important to speak to a financial representative before you invest in these types of bonds, because if you are not careful you may purchase them from an issuer who is in poor financial shape. If you are simply interested in a bond that will serve as an alternative method of saving money, you will want to choose a reliable issuer.