Serial bond definition
/What is a Serial Bond?
A serial bond is a bond issuance where a portion of the total number of bonds are paid off each year. This results in a gradual decline in the total amount of the issuer's debt outstanding. For example, a $1,000,000, ten-year serial bond will have $100,000 of bonds mature once a year for ten years.
A serial bond is designed to support the financing needs of a capital project that delivers a steady stream of funds to pay down the debt over time. For example, a toll road may require initial funding with a bond issuance, after which toll proceeds are used to pay off the bonds over a long period of time. The same situation arises for an apartment complex, where bonds are used to pay for construction of the complex, and the resulting rents are used to pay for the bonds.
Features of a Serial Bond
The main features of a serial bond are as follows:
Staggered maturity dates. There are different maturity dates linked to the various serial bonds that an issuer has sold to investors, so that they are redeemed on different dates.
Match to cash flows. The ongoing redemption of bonds is directly linked to the ongoing cash inflows from the project that the bond issuance was intended to fund. As the cash comes in, it is used to pay off the bonds.
Declining interest expense. Given the ongoing redemption of bonds, the issuer will recognize a declining amount of interest expense over time.
Because of the varying durations of these bonds, they may attract a variety of investors who are interested in investing over varying periods of time.
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The Difference Between a Serial Bond and a Sinking Fund
A sinking fund is a set-aside of cash that is used by a trustee to retire bonds by buying them on the open market from any bondholder willing to sell them. Conversely, a serial bond is designed to retire bonds in accordance with a specific schedule. In both cases, the amount of bonds outstanding will decline over time.
Disadvantages of Serial Bonds
Serial bonds have several disadvantages, depending on the context of their issuance and management. Here are some of the key drawbacks:
Complex administration. Each maturity in a serial bond issue may have a different interest rate and principal repayment schedule. This can make tracking payments and recordkeeping more complicated compared to a single maturity date of term bonds.
Higher initial costs. Issuing serial bonds can involve higher initial administrative and legal costs due to the complexity of the structure and the need to set up multiple maturity schedules.
Reduced marketability. The staggered maturities can reduce liquidity in secondary markets, as each tranche may attract a smaller pool of buyers compared to a larger single-issue term bond.
Refinancing challenges. If interest rates drop, refinancing or restructuring a serial bond issue can be more complicated since different portions of the debt mature at different times.
Challenging cash flow management. For the issuer, the varying repayment amounts over time can make budget planning more challenging compared to the fixed cash flow associated with term bonds.
Possibly higher overall costs. Serial bonds can have varying interest rates across different maturities. If longer maturities have higher rates, the issuer may end up paying more in interest over time compared to a term bond with a single rate.
Investor confusion. The structure of serial bonds may be less straightforward to less sophisticated investors, potentially reducing demand for the bond issue.
By weighing these disadvantages against their benefits, issuers can decide whether serial bonds align with their financial goals.
Advantages of Serial Bonds
The advantage to the issuer of a serial bond is that less interest will be paid over the life of the bonds, since the aggregate amount of cash loaned to the issuer is greatly reduced. The advantage to the investor is the reduced risk of default, since the issuer's repayment liability is constantly declining.