Term bonds are bonds within a single issue that share one maturity date. The issuer pays interest periodically, usually every six months, and repays the entire principal at the end of the term in one payment, a structure known as bullet repayment. Most corporate bonds and US Treasury notes and bonds are term bonds in this sense.
The term is used mainly to contrast them with serial bonds, where portions of the issue mature on different dates, so the issuer repays the debt gradually. Serial structures are common in US municipal finance, where a city may issue bonds maturing each year from 2027 to 2046. Many municipal issues combine the two, with serial bonds for the earlier years and one or more term bonds for the later years.
How term bonds work
A company that issues $50 million of ten-year term bonds with a 5 percent coupon rate pays $1.25 million of interest every six months, $2.5 million a year, and repays the full $50 million at the end of year ten. Because the whole principal falls due at once, investors face the risk that the issuer will not have enough cash or will be unable to refinance at maturity. To reduce this risk, the bond indenture may require a bond sinking fund, under which the issuer sets aside money each year or retires part of the bonds early, usually by lottery call at par or by buying them in the market.
Term bonds may also be callable, allowing the issuer to redeem them before maturity at a set price, which is attractive when interest rates fall. Investors in callable bonds are usually compensated with a higher yield.
Accounting for term bonds
The issuer records term bonds as bonds payable at face value, with any premium or discount recorded separately and amortized over the term, normally by the effective interest method. Interest expense is recognized each period. The bonds are classified as long-term liabilities until the year before maturity, when they are reclassified as current unless the issuer plans to refinance them on a long-term basis and meets the accounting conditions to do so, or a sinking fund held as a noncurrent asset will be used to repay them.
If ten-year 5 percent bonds with face value of $50 million are issued when the market interest rate is 5.5 percent, the price is below face value. Using the present value of the interest payments and principal, the bonds sell for about $48.1 million. The discount on bonds payable of about $1.9 million is amortized over ten years, raising the interest expense above the $2.5 million cash coupon each year. At maturity the carrying amount equals $50 million, and the repayment entry debits bonds payable and credits cash for $50 million.
Term bonds compared with serial bonds
| Feature | Term bonds | Serial bonds |
|---|---|---|
| Maturity | One date for the whole issue | Several dates, often annual |
| Principal repayment | Lump sum at the end | Installments over the life |
| Refinancing risk | Concentrated at maturity | Spread out |
| Interest cost | Interest paid on the full principal throughout | Total interest falls as bonds are repaid |
| Typical users | Corporations, governments, long-dated municipal maturities | Municipalities, equipment financing |
Investors who want a single, predictable maturity date, such as pension funds matching a known future obligation, often prefer term bonds, while serial bonds let investors choose from a range of maturities. Issuers choose between them based on their expected cash flows: a toll road with steadily growing revenue may favor serial maturities, while a company expecting to refinance in the capital markets may prefer term bonds. The yield to maturity on term bonds of different lengths together forms the yield curve that investors use to compare corporate bonds and government securities.