Income Bonds – An Overview:
Bonds are usually considered fixed-income debt instruments. Large financial institutes and corporations issue bonds making these debt instruments secured loans.
Some corporate bonds come with certain features and covenants that make them different in nature.
Income bonds are a type of corporate bond where the issuer pays interest only with earnings.
Usually, bond issuers offer regular coupon payments to attract investors. Coupon payments with income bonds are not an obligation to the issuer.
By definition, income bonds closely resemble preferred shares. The issuer can make interest payments if they make enough profits.
Income bonds also work similarly; they make coupon payments in preference to other securities but not on an obligatory basis.
How Income Bonds are Different?
Bond features and characteristics define the variety. Income bonds are somewhat the opposite of straight bonds (making interest-only payments) and Zero-Coupon bonds that pay no interest. Some issuers make coupon payments on an accrual basis if they cannot make regular payments.
The issuers may use the option of making a large accrued coupon payment at maturity or offer a share exchange to the bondholder.
Corporate issuers rarely use Income bonds as they cannot attract investments without a guaranteed return.
Like zero-coupon or deep discount bonds, the issuers may have to offer a discount on face value or the convertibility feature to attract investors.
Characteristics of Income Bonds:
The speculative nature of coupon payment is the prime characteristic of an income bond. However, corporate bond issuers have to offer certain benefits to attract investors.
Companies with consistent cash flows and sufficient funds would prefer other forms of bonds to attract investments.
Large companies struggling with solvency or liquidity crunch may consider income bonds. The prime motive behind issuing income bonds is to avoid consistent coupon payments yet attracting investment.
Income bonds usually come with the following characteristics:
- Income Bonds do not offer regular coupon payments but only with sufficient earnings
- Income bonds are issued with higher interest rates
- Income bonds only guarantee principal repayments as a legal obligation
- Some Income bonds also offer stock convertibility at maturity against the accrual interest payments or principal amount
Risks and Benefits for Investors with Income Bonds:
Bonds are low-risk low-reward debt instruments offering regular interest payment options. The creditworthiness of large financial institutes and corporations makes these investments safe investment.
Issuers usually offer low-interest rates and discount on face value to attract investments. In some cases, corporate bond issuers may not enjoy high credit ratings and are compelled to issue deep discounts or income bonds.
Mostly income bonds are issued by companies struggling with cash funds or corporate restructuring issues.
That makes the investment in income bonds a risky venture. However, these bonds are issued at discount and offer high-interest rates.
Investors may gain quick rewards if they can short-sell income bonds in the secondary markets.
Investors can expect additional features with income bonds such as stock conversion upon maturity or interest accrual option.
Risks and Benefits for Issuers with Income Bonds:
Companies issuing income bonds face the biggest risk of default of repayment. These firms issue income bonds often with low credit ratings and liquidity issues.
With low credit ratings, income bonds may not attract enough investment that can take the company out of the financial imbroglio.
The biggest benefit for the issuers comes with an interest payment. The company can decide on the sufficiency of income level to make the coupon payments on income bonds, much like dividend decisions.
Unlike dividends, companies can enjoy tax benefits with interest payments on income bonds though.
When Income Bonds Are Issued?
If interest payments are not guaranteed with zero-coupon bonds, the credit rating and discount price work for the issuers. Income bond issuers usually face a cash crunch with low credit ratings.
Most corporate issuers use income bond options with debt restructuring. A large company with a long corporate history may face debt insolvency or a liquidity crunch.
A large one-time investment much like a bailout package may help the company.
Investors usually look for a high-interest rate, lower market price, and additional features such as convertibility to make risky investments.
Large firms issue income bonds while they look to continue operational activities without legally committing to regular interest payments.
The Bottom Line:
Income bonds do not offer regular coupon payments. The issuer may make coupon payments with sufficient earnings but only the principal repayment is a legal obligation. Companies usually issue these bonds with low credit ratings.
These bonds are often issued with higher interest rates and discount market prices than the face value of the bond.