What is an Amortized Bond?

What is an Amortized Bond?

An amortized bond is one in which the principal (face value) on the debt is paid down regularly, along with its interest expense over the life of the bond. A fixed-rate residential mortgage is one common example because the monthly payment remains constant over its life of, say, 30 years.

However, each payment represents a slightly different percentage mix of interest versus principal. An amortized bond is different from a balloon or bullet loan, where there is a large portion of the principal that must be repaid only at its maturity.

How an Amortized Bond Works

If the bond matures after 30 years, for example, then the bond’s face value plus the interest due is paid off in monthly installments. The bondholder essentially occupies the same type of position as a bank or other lender that extended a 30-year mortgage to a homebuyer – that is, they will receive regular payments of both principal and interest over the life of the bond, just as a mortgage lender receives regular payments over the term of a mortgage loan.

In most cases, the calculation for payments on an amortized bond is completed in such a way that each payment is the same amount. The only difference is the composition of the payment – the percentage of the payment going towards interest and the percentage of the payment going towards the principal varies, with more of the payment going towards interest early on and more going toward the principal as the bond gets closer to its maturation date.

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A General Categorization of Bonds

There are broadly five categories of bonds:

Based on the Issuer:

  • Corporate –Issued by companies due to more favorable terms of borrowing.
  • Government (Sovereign) – Issued by a country’s treasury/central bank and are also popularly known as T-bonds/G-secs.
  • Municipal –Issued by the state governments/municipalities.
  • Agency – Issued by government-affiliated organizations.

Based on the Taxability:/h4>

  • Taxable – These attract taxes, often to be paid as LTCG at maturity
  • Tax-exempt – These do not attract taxes.

Based on the Maturity term:

  • Short Term – Mature in 1-5 years.
  • Intermediate-Term – Mature in 5-10 years.
  • Long Term – Mature in 10-30 years.
  • Serial – Mature in a phased manner, with varying maturity terms.
  • Perpetual/Consolidation/Perp – They do not have a maturity date and are often understood more like equity rather than a debt instrument.
  • Callable – Accompany a clause of redeemability by the issuer.

Based on Purpose:

  • Mortgage – Accompany a claim on the real estate used as collateral.
  • Subordinated – Paid back after preferential/primary bonds in case of liquidation of the issuer.
  • Bearer – Claimed by anyone bearing the document of a bond.
  • Climate – Used to specifically counter the adverse effects of climate change.
  • War – Specifically used to fund an ongoing/perceived war.

Based on Interest:

  • Fixed/Bullet – Carries fixed predefined coupon rates.
  • Floating/Amortized – Carries floating coupon rates.

Zero – No coupon rates.

  • Inflation-linked – Carries lower coupon rates, which are adjusted with inflation rates.

Benefits of Amortized Bonds

A bond is a limited-life intangible asset. Amortizing a bond can be significantly beneficial for a company because the business can gradually cut down the bond’s cost value.

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Accountants are able to respond to a bond as if it were an amortized asset. It essentially means that the entity issuing the bond gets to document the bond discount like an asset for the entirety of the bond’s life. It can only happen if the bond’s issuer is selling the bond at a discount, meaning the issuer lets the buyer purchase the bond for less than par, or face value.

Amortization is ultimately an accounting tactic that benefits an issuer when it comes time to filing taxes. An amortized bond’s discount is listed as a portion of the issuer’s interest expenses on its income statement. Interest expenses are non-operating costs and are crucial in helping a business to cut down on its earnings before tax (EBT) expenses.