Comprehensive Guide, Examples & Comparison With Amortizing Bonds

What Is a Bullet Bond?

A bullet bond is a type of debt investment that repays its full principal value in a single lump sum at maturity rather than through periodic payments. Governments and corporations issue bullet bonds to secure long-term funding, with returns tied to the issuer’s credit quality.

While these bonds offer predictable payments and low default risk, especially for government issues, they lack flexibility since they can’t be redeemed early. Investors generally receive lower yields than on callable or amortizing bonds in exchange for stability and simplicity.

How Bullet Bonds Work and Their Risks

Both corporations and governments issue 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 bond is generally considered riskier to its issuer than an amortizing bond because it obliges the issuer to repay the entire amount on a single date rather than in a series of smaller repayments over time.

As a result, issuers who are relatively new to the market or who have less than excellent credit ratings may attract more investors with an amortizing bond than with a bullet bond.

Typically, bullet bonds are more expensive for the investor to purchase compared to an equivalent callable bond since the investor is protected against a bond call if interest rates fall.

Comparing Bullet Bonds to Amortizing Bonds: Key Differences

Bullet bonds differ from amortizing bonds in their method of payment. Amortized bonds are paid in regular installments that cover interest and principal, fully repaying the loan by maturity.

In contrast, bullet bonds may require small, interest-only payments, or no payments at all, until the maturity date. On that date, the entire loan plus any remaining accrued interest must be repaid.

Pricing Example: How to Calculate the Present Value of a Bullet Bond

Pricing a bullet bond is straightforward. First, the total payments for each period must be calculated and then discounted to a present value using the following formula:

Present Value (PV) = Pmt / (1 + (r / 2)) ^ (p)

Where:

• Pmt = total payment for the period
• r = bond yield
• p = payment period

For example, imagine a bond with a par value of $1,000. Its yield is 5%, its coupon rate is 3%, and the bond pays the coupon twice per year over a period of five years.

Given this information, there are nine periods for which a $15 coupon payment is made, and one period (the last one) for which a $15 coupon payment is made and the $1,000 principal is repaid.

Using the formula, the payments will be as follows:

1. Period 1: PV = $15 / (1 + (5% / 2)) ^ (1) = $14.63
2. Period 2: PV = $15 / (1 + (5% / 2)) ^ (2) = $14.28
3. Period 3: PV = $15 / (1 + (5% / 2)) ^ (3) = $13.93
4. Period 4: PV = $15 / (1 + (5% / 2)) ^ (4) = $13.59
5. Period 5: PV = $15 / (1 + (5% / 2)) ^ (5) = $13.26
6. Period 6: PV = $15 / (1 + (5% / 2)) ^ (6) = $12.93
7. Period 7: PV = $15 / (1 + (5% / 2)) ^ (7) = $12.62
8. Period 8: PV = $15 / (1 + (5% / 2)) ^ (8) = $12.31
9. Period 9: PV = $15 / (1 + (5% / 2)) ^ (9) = $12.01
10. Period 10: PV = $1,015 / (1 + (5% / 2)) ^ (10) = $792.92

These 10 present values equal $912.48, which is the price of the bond.

The Bottom Line

Bullet bonds are non-callable debt instruments that repay the full principal in a single lump sum at maturity. Compared to amortizing bonds, they pose higher repayment risk for issuers but offer investors predictable returns and protection from early redemption.

Stable governments often issue them at lower interest rates, while corporations with lower credit ratings pay more. Their value is calculated by discounting future payments to present value, reflecting both interest rate conditions and issuer risk.