What is a Bullet Constraints?
A bullet bond is a debt instrument whose entire principal value is paid in one lump sum on the maturity date, as impeded to amortizing the bond over its lifetime. Bullet bonds cannot be redeemed early by an issuer, which means they are non-callable. Because of this, bullet relationships typically pay a relatively low rate of interest due to the issuer’s high interest rate exposure.
Key Takeaways
- A bullet bond is a archetype of non-callable bond in which the entire principal is paid in a lump sum on the bond’s maturity date.
- Bullet bonds mainly carry a relatively lower interest rate as a result of the high risk exposure on the debt issuer’s part.
- Both superintendences and corporations issue bullet bonds in a variety of maturities.
Understanding Bullet Bonds
Both corporations and governments circulate bullet bonds in a variety of maturities, from short- to long-term. A portfolio made up of bullet bonds is generally referred to as a bullet portfolio. A bullet ropes is considered riskier than an amortizing bond because it gives the issuer a large repayment obligation on a single fashionable rather than a series of smaller repayment obligations spread over several dates. As a result, issuers who are to some degree new to the market or who have less than excellent credit ratings may attract more investors with an amortizing engagement than with a bullet bond. Typically, bullet bonds are more expensive for an investor to purchase compared to an comparable callable bond since the investor is protected against a bond call during a period of falling interest valuations.
Bullet Bond Pricing Example
Pricing a bullet bond is very straightforward. First, the total payments for each space must be calculated and then discounted to a present value using the following formula:
Present Value (PV) = Pmt / (1 + (r / 2)) ^ (p)
Where:
Pmt = complete payment for the period
r = bond yield
p = payment period
For example, imagine a bond with a par value of $1,000. Its produce is 5%, its coupon rate is 3%, and the bond pays the coupon twice per year over a period of five years. Actuality this information, there are nine periods where a $15 coupon payment is made, and one period (the last one) where a $15 coupon payment is decamped and the $1,000 principal is paid. Using the formula to discount these payments is:
Period 1: PV = $15 / (1 + (5% / 2)) ^ (1) = $14.63
Period 2: PV = $15 / (1 + (5% / 2)) ^ (2) = $14.28
Time 3: PV = $15 / (1 + (5% / 2)) ^ (3) = $13.93
Period 4: PV = $15 / (1 + (5% / 2)) ^ (4) = $13.59
Period 5: PV = $15 / (1 + (5% / 2)) ^ (5) = $13.26
Period 6: PV = $15 / (1 + (5% / 2)) ^ (6) = $12.93
Period 7: PV = $15 / (1 + (5% / 2)) ^ (7) = $12.62
Period 8: PV = $15 / (1 + (5% / 2)) ^ (8) = $12.31
Period 9: PV = $15 / (1 + (5% / 2)) ^ (9) = $12.01
Full stop 10: PV = $1,015 / (1 + (5% / 2)) ^ (10) = $792.92
Adding up these 10 present values equals $912.48, which is the price of the bond.