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What is a Serial Bond?

Serial Bond

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Serial Bond

A serial bond is a type of bond issue that is structured so that a portion of the outstanding bonds matures at regular intervals until all of the bonds have matured. Because of this structure, serial bonds are used to match the bond maturities with a series of staggered cash flows, making them useful for funding projects that generate steady revenue streams over time.

Key features of serial bonds:

  • Staggered Maturities: Unlike term bonds, which mature at one specific date in the future, serial bonds have multiple maturity dates spread out over several years.
  • Decreasing Interest Expense: As portions of the serial bond issue mature and are paid off over time, the total amount of outstanding debt decreases. This, in turn, reduces the issuer’s interest expense over the life of the bonds.
  • Matched Financing: Serial bonds can match the financing needs of projects with revenues that increase over time. As revenues rise, portions of the bond issue mature and are paid off, aligning with the increasing revenue stream.
  • Appeal to Different Investors: Since serial bonds have a range of maturity dates, they can appeal to various investors with different time horizons and yield requirements.

Example of a Serial Bond

A school district plans to build several schools over the next five years to accommodate a rapidly growing population. The district decides to issue serial bonds to finance the construction.

Bond Details:

  • Total Bond Value: $50 million
  • Duration: 5 years
  • Interest Rate: 5% annually

Instead of issuing a term bond that matures in 5 years for the full amount, the school district structures the bond as follows:

Year 1:

  • Amount Maturing: $8 million
  • Interest Payment: 5% of ($50 million) = $2.5 million
  • Total Payment: $8 million (principal) + $2.5 million (interest) = $10.5 million

Year 2:

  • Amount Maturing: $10 million (since the population growth rate and consequently, the school building rate is increasing)
  • Remaining Principal after Year 1: $50 million – $8 million = $42 million
  • Interest Payment: 5% of ($42 million) = $2.1 million
  • Total Payment: $10 million (principal) + $2.1 million (interest) = $12.1 million

Year 3:

  • Amount Maturing: $12 million
  • Remaining Principal after Year 2: $42 million – $10 million = $32 million
  • Interest Payment: 5% of ($32 million) = $1.6 million
  • Total Payment: $12 million (principal) + $1.6 million (interest) = $13.6 million

… and so on for Years 4 and 5.

Benefits for the School District:

  • Decreasing Interest Payments: As seen in the example, the interest payments decrease each year as a portion of the principal is repaid.
  • Flexibility in Repayment: By matching bond maturities with the expected completion of each school, the district can align its debt repayments with its financing needs.
  • Diversified Investor Appeal: Some investors may prefer the short-term maturities (like Year 1 or 2 bonds) while others may be interested in longer-term maturities (like Year 4 or 5 bonds). This diversification can potentially increase the demand for the bonds.

Benefits for Investors:

  • Range of Maturity Choices: Investors have the flexibility to choose which year’s bond they’d like to invest in based on their financial goals and time horizons.
  • Potential for Higher Interest Rates: Since serial bonds carry a staggered maturity, earlier maturities might have lower yields compared to later maturities, which could be more attractive to some investors.

This example illustrates how a serial bond issuance provides flexibility for both the issuer (the school district) and the investors, making it a beneficial financing tool for long-term projects with staggered cash flow needs.

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