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Types of bonds

Find out how different types of bonds can be used to achieve different investment objectives

Fixed rate bonds pay a fixed rate of interest (the coupon rate) for the life of the bond. As fixed rate bonds pay interest at a fixed rate, they carry interest rate risk as well as credit quality risk. If market interest rates rise or the financial health of the issuer deteriorates, investors may demand a greater yield and the price of the bond will generally fall.

Floating rate bonds make interest payments that are tied to some measure of current interest rates. A common measure is the 90 day Bank Bill Swap Rate or BBSW (a benchmark rate based on actual transactions in bank bills and negotiable certificates of deposit). Typically, the coupon will be expressed as a fixed margin above the benchmark rate (e.g. BBSW plus 2%).

Indexed bonds are generally medium to long-term bonds. The face value of the bond is adjusted periodically for movements in a nominated index, such as the Australian Consumer Price Index (CPI) or an index tied to the price of a particular commodity. Interest is usually paid at a fixed rate on the adjusted face value. At maturity, investors receive the adjusted face value of the indexed bond plus the final coupon based on the adjusted face value. Indexed bonds that are tied to a general measure of inflation (such as the CPI) can ensure you receive a return above the inflation rate throughout the life of the bond, giving you security while reducing inflation risk. To compare the expected coupon payments on an indexed bond tied to CPI with that of a fixed rate bond, you simply add the expected inflation rate to the coupon rate of the indexed bond.

Type of issuer

Simple bonds

A bond is regarded as a 'simple bond' if: 

  • it has a fixed or floating coupon rate that does not change for the life of the security
  • interest payments under the security are paid periodically and cannot be deferred or capitalised by the issuer
  • it has a fixed maturity date which is not moer than 15 years after its date of issue
  • it is not subordinated to other debts owed to unsecured creditors generally, and
  • it does not have any options to convert it to equity or to extinguish it (so-called 'knock-out' options).

Complex bonds

Examples of more complex bonds include:

  • bonds that allow the issuer to defer or capitalise interest payments under certain conditions 
  • bonds that provide for the coupon rate to be re-set at certain times (often called ‘re-set’ or ‘re-settable’ bonds) 
  • bonds that give the issuer the option to extend them but at the price of paying a higher coupon rate (typically called ‘step-up bonds’) and 
  • bonds that are more like hybrid securities, combining features of debt securities and shares. 

Understanding bonds