A Straight bond is the most basic form of bond. It comes with the most basic features associated with a bond. All other types of bonds are variants of the straight bond. It comes with no special features or variations attached to it.
Bonds are debt instruments used by Governments, Municipal Corporations, Large corporate entities, and businesses. Bonds can be issued by any company; it largely depends on the creditworthiness of the issuer. Investors look for a stable income with bonds through coupon payments.
Deeper Definition
A straight bond or a plain bond is the most basic type of bond. It pays consistent coupon payments and repays the principal amount at maturity.
Bonds can take several variants by embedding different features and covenants. A bond without coupon payments is called a zero-coupon bond. Similarly, a redeemable bond is termed a callable or redeemable bond. All of these bonds are variants of the plain/straight bond. In that sense, any type of bond with special features is this bond plus the special feature/covenant attached to it.
How Does a Straight Bond Work?
Corporations and large companies raise capital through bonds. Bonds are debt instruments that lower the total cost of capital for the borrowers. They can take advantage of lower interest rates offered on bonds as compared to bank loans. A straight bond is the basic form of these debt instruments that are issued with basic features.
It offers coupon payments and a promised repayment of the principal amount at maturity. It does not include any special features of covenants such as the call feature to redeem the bond before maturity. The simplistic framework makes it easier for investors and borrowers to commit their positions.
Bonds are debt instruments that are considered beneficial for investors and borrowers alike. Borrowers can reduce their cost of capital through cheap financing with bonds. Investors look for consistent and regular income through coupon payments from bonds. It offers that flexibility to investors and borrowers in the simplest terms.
Special Considerations with a Straight Bond
Straight bonds offer regular income features to investors. The prime features of this bond are its interest rate, coupon payment interval, and repayment at maturity. There are no special features or covenants with this bond.
Since they do not embed any special features, they often lack the flexibility investors look for. For compensation, borrowers often place the straight bonds at below par face value in the market. It attracts investors to buy these bonds at below par value and sell at higher prices in the market. Some investors hold these bonds to maturity to redeem them at face value at maturity. Their prime objective is to earn consistent coupon payments from a straight bond.
Investors make money on straight bonds through coupon payments at repayment of the principal amount. Once the interest rate and payment intervals are decided, the income portion of this bond is fixed. Investors can make money by selling the bond at a premium to the original price or holding it to maturity. However, this depends on the buying price of the bond. If the investors buy the bond at above face value, they’ll redeem it at a loss at maturity. If they buy the bond at below par value, they’ll redeem at a profit at maturity.
Example
Suppose a company issues a bond at a face value of $ 1,000 with a 3% interest rate and a maturity of 10 years. The bond will make a $30 coupon payment yearly for 10 years. If the bond is offered are $950 (at discount), the investor can redeem the bond at maturity for $1,000 at face value after 10 years. Often, investors trade bonds at a premium, say in this case, for $970 to make quick gains.
Advantages of a Straight Bond
Although straight bonds are the simplest form of debt instruments, they come with several advantages.
- Investors can make consistent income with a straight bond through regular coupon payments.
- Borrowers can lower the total cost of capital through low-cost straight bonds.
- These bonds are easier to evaluate.
- These bonds are highly liquid that makes them good marketable securities.
- Investors can lower their portfolio investment risk with these bonds.
Disadvantages of a Straight Bond
Straight bonds can offer some limitations as well.
- Straight bonds come with interest rate and default risk as is the case with any type of bond.
- These bonds also carry volatility risk.
- These bonds do not embed any special features to attract investors.
- Interest rate risk also affects the pricing of these bonds in the secondary market.
Conclusion
A straight bond comes with the basic feature of a debt instrument. It pays regular coupon payments and principal repayment to the investors. Straight bond does not embed any special feature or covenants. It comes with interest rate and default risk as in the case of any type of bond.
