Meaning of Income Bonds

Meaning of Income Bonds

An income bond is defined as a debt instrument whereby the issuer pays the principal only and the coupon payments are subject to available earnings. In other words, the issuer is liable to pay the coupon payments only when it has income in its financial statements. From an issuer’s point of view, such bonds are very beneficial as it makes available capital easily without any interest obligations. On the contrary, it is not a preferred instrument for the investor because he will have to bear the additional uncertainty of the generation of income by the issuer.

Corporate Bonds vs Income Bonds

As we know, most corporates and governments issue bonds regularly, and there is a big market available for all such bonds. Moreover, a heavy volume of trade happens in those bonds. All these bonds carry a coupon rate/interest payment rate. And, the corporates and the governments promise to pay the interest as per the coupon rates regularly at the defined intervals. All these bonds further guarantee for payment of principal as per the issue terms. In summary, all these bonds regularly pay the interest and principal on maturity. Depending upon the financial strength and their track record with regard to the timely payment of interest and principal, these bonds carry ratings by credit rating agencies.

Similarly, in the case of income bonds, the bonds also carry the coupon rate. And guarantees repayment of the principal on maturity. However, the issuer has no obligation or compulsion to pay the interest regularly. Provided the income is insufficient to take care of the interest obligations during that period. Thus, the interest payment remains uncertain for the investors. Moreover, it neither has a provision to carry over the unpaid interest portion.

Income Bonds vs Preference Shares

Income bonds look very similar to preference shares with respect to the payment of regular dividends. So in both cases, if the income is not sufficient to pay, then the interest (for income bonds) or dividend (for preference shares) payment is not compulsory for the company.

However, in preference shares, if the dividend is not paid in a particular year, then the unpaid dividend for that year will be accumulated. And paid in the subsequent year when there will be sufficient income. This is not the case with income bonds, and this is how they are different from each other. However, it is all about structuring an instrument. Because, it is similar to an agreement between two parties, and it can be structured at the convenience of the two.

Benefits to Issuer

This type of bond is very appropriate in times of financial crisis or when the company is undergoing a financial restructuring. It allows the company to avail capital easily in times of uncertainty and crisis without any obligation for regular payment of interest. Of course, investors must be ready to subscribe. The direct benefit of this bond is that it can prevent a company from bankruptcy.

Due to the typical nature of income bonds, these are rare and not regularly issued. Income bonds are generally issued by companies having solvency issues and where interest payment certainty is not there.

NSI Income Bonds

NS&I is a UK-based saving organization working on getting cost-effective funds to the government from the public. Income bonds are one of the many saving products of NSI offered to the public.

NSI income bonds are accessible to a person aged 16 or more. The interest rate on the bonds is variable. And this can increase or decrease depending on the reference rate change by the Bank of England base rate. The investment can range between 500 pounds to 1 million pounds. One can access the best income bond funds offered by NSI from their website.

Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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