Bullet Bond

A bullet bond is a bond whose whole principal is repaid in one payment on the maturity date. Until then the holder receives interest only, normally as a fixed coupon paid once or twice a year. The structure is also called a straight bond or plain vanilla bond when it has a fixed coupon and no option for early repayment.

Bullet bonds are the standard form of debt for governments and large companies. The contrast is with the amortising bond, which returns principal in instalments, and with bonds that can be redeemed early, such as a callable bond. In loan markets the same repayment pattern is known as a bullet repayment.

The cash flows of a bullet bond are simple and known in advance: a series of equal coupon payments followed by the final coupon and the face value on the maturity date. A ten-year bond with a face value of 1,000 and a 4% annual coupon pays 40 each year for nine years and 1,040 in the tenth.

A strict bullet is non-callable, so neither the issuer nor the holder can change the timing. In practice many corporate bullets include a make-whole call or a short par call window before maturity, which seldom alters the expected cash flows. A zero-coupon bond is the extreme case: it makes no payments at all until a single one at maturity.

For the issuer, a bullet keeps cash in the business for the full term. Only interest must be found each year, which suits borrowers that expect to refinance or to repay from a future event, and it keeps annual debt service low. Bullets are also easy to document, price and trade, so they attract the widest range of investors and the lowest cost of borrowing.

Governments build their borrowing around bullets. Large benchmark issues at standard maturities, such as Treasury bonds in the United States, are reopened repeatedly to build size and liquidity, and their yields form the reference curve for the rest of the market. Most investment-grade corporate bonds follow the same pattern.

A bullet is valued by discounting each coupon and the final principal at the market yield, as set out under bond pricing. Because the largest payment comes at the very end, a bullet has a longer duration than an amortising bond with the same coupon and final maturity. Its price is therefore more sensitive to changes in interest rates; this is its interest rate risk.

The absence of options makes the measures easy to interpret. The yield to maturity is the return an investor earns if the bond is held to the end and coupons are reinvested at the same rate. Market participants quote corporate bullets as a spread over a government bullet of similar maturity on the yield curve, which isolates the compensation for credit risk.

The defining risk for the issuer is refinancing risk. The whole principal falls due on one day, and if the issuer cannot repay from cash or raise new debt at that moment, it defaults. Market conditions on a single date therefore matter greatly. Issuers manage this by spreading maturities across many years in a balanced maturity profile, by refinancing ahead of time, and sometimes by buying bonds back before they fall due.

For the investor, credit exposure stays at its full level until the last day, unlike an amortising bond where it shrinks over time. A weakening issuer may keep paying coupons for years and then fail at maturity. This is often called balloon risk, by analogy with loans that end in large balloon payments. Investors are compensated with a credit spread that generally rises with maturity.

Reinvestment risk, on the other hand, is lower for principal than with amortising or callable bonds, since no capital is returned early. It applies only to the coupons.

The alternatives to a bullet all spread or advance the repayment of principal:

• Amortising bonds. Principal is repaid in scheduled instalments, which lowers credit and refinancing risk but complicates administration.
• Sinking fund bonds. The issuer retires part of the issue each year through a sinking fund, while each individual bond still repays in one amount.
• Callable and puttable bonds. Early repayment is possible at the option of the issuer or the holder, making the maturity uncertain.
• Soft bullets. Used in covered bonds and securitisations, these have an expected maturity date that can be extended for a set period if the issuer cannot pay on time, without causing a default.

The final repayment is handled like any other bond redemption, through the paying agent and the depositories.

The word is also used for a way of arranging a bond portfolio. In a bullet strategy, an investor buys bonds that all mature around the same date, typically to meet a known future liability. This contrasts with a ladder, in which maturities are spread evenly, and a barbell, which combines short and long maturities and leaves out the middle. A bullet portfolio has cash flows concentrated at one point and behaves much like a single bond of that maturity. Most bullets carry a fixed coupon, as described under fixed-rate bond, though floating-rate notes also repay in a single amount.