Did you know that not all bonds repay the money you invest in the same way? Some return the principal in parts, just like interest payments, while others repay the entire principal in one go at maturity.
If your aim for investing in debt instruments is to meet specific financial goals like education fund, a wedding or buying a home, investing in bonds who pay the principal amount as a lump sum at maturity is a more practical option. These bonds are known as bullet bonds.
In this blog, we will discuss what a bullet bond is, its features, strategies, and much more. Let’s delve in.
What is a Bullet Bond?
A bullet bond is a fixed-income security which pays back an investor’s entire principal amount in one lump sum at maturity. These bonds are one of the most common types of bonds issued in India.
Here, the issuer pays interest (coupon) periodically as stated in the contract. At maturity, the bondholders receive their principal amount in one go rather than being amortized over time. The name “bullet” comes from the sudden, full repayment of principal at maturity, suggesting a bullet hitting its target in a single strike.
Bullet bonds are also called non-amortizing bonds. While they are often non-callable, a bullet bond is not the same as a non-callable bond. A bullet bond’s defining feature is the lump-sum repayment of principal at maturity. Therefore, a bullet bond can be callable or non-callable. Both corporations and governments issue these bonds to fund inventory, refinance existing debt or infrastructure projects.
Now that you have a better understanding of bullet bonds, let us discuss what makes these bonds unique.
Key Features of Bullet Bonds
Bullet bonds carry unique characteristics that make them attractive to certain investors and issuers alike. Here are five key features of bullet bonds:
- Lump-Sum Principal Repayment: Investors receive the full principal at maturity and not in instalments.
- Regular Coupon Payments: Most bullet bonds pay fixed interest at scheduled intervals, ensuring investors have a predictable cash flow.
- Non-Callable Nature: Most of the bullet bonds are non-callable as they are non-amortizing bonds in nature.
- Variety of Issuers: From governments to corporations, issuers use bullet bonds to raise capital for projects, infrastructure, or refinancing.
- Yield Profile: Bullet bonds often offer higher yields compared to government bonds, but typically lower than callable bonds with the same maturity and credit quality, since the investor sacrifices call risk protection.
This set of unique features lets investors use these bonds in a more flexible manner to counter bond-associated risks. Let’s look at the strategies investors use with bullet bonds to tackle potential risks.
Understanding the Bullet Bond Strategy
Investors execute different types of strategies to make the most out of the stability and predictability bullet bonds offer. The following are the three most common types of bullet bond strategies:
Ladder Strategy
In a ladder strategy, bondholders park their capital across different bonds having different maturities. For example, to tackle interest rate risk, an investor can buy bullet bonds having varied maturities of 1, 3 and 5 years respectively. As each bond matures, the investor puts back the received principal into a new long-term bond at the far end of the ladder.
This approach ensures that investors always have bonds coming due, providing steady liquidity while also keeping part of the portfolio invested for higher yields. It’s a balanced way to manage both cash flow and interest rate risk.
Barbell Strategy
In a barbell strategy, investors concentrate their holdings in short-term and long-term bullet bonds while skipping the intermediate maturities. For example, an investor might allocate half the portfolio to 1-year bonds and the other half to 10-year bonds. This mix allows them to maintain liquidity and flexibility from the short-term bonds while benefiting from the potentially higher yields of long-term bonds.
Rolling Ladder Strategy
The rolling ladder strategy is a more advanced version of the ladder. Here, investors continuously reinvest the proceeds from maturing bonds into new ones, thereby maintaining a consistent spread of maturities over time. This creates a self-sustaining cycle that offers ongoing cash flow, reduces reinvestment risk, and gives long-term exposure to the bond market.
For conservative investors seeking further diversification and more liquidity, bullet bond ETFs provide an alternative approach. Here’s how they work
Bullet Bond ETFs: How They Work
Bullet bond ETFs package a diversified basket of bullet bonds that share a common maturity or a tight maturity window into a single, tradable fund. These ETFs offer investors with:
- Diversification: Holding dozens of issuers reduces credit risk compared to a single bond.
- Liquidity: ETF shares trade on the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE), enabling easy access and exit, unlike some individual bonds with lower liquidity in the secondary markets.
- Transparency: Net-asset-value disclosures reveal holdings and average maturity, so investors know the expected payoff date.
For example, an ETF tracking five-year bullet investment-grade corporate bonds holds securities that mature in five years. Interest accrues to the fund and is reflected in NAV; some ETFs also pay periodic distributions. When underlying bonds mature, the fund either reinvests proceeds as per its mandate or distributes them (in the case of a target-maturity ETF that winds up), and the NAV adjusts accordingly.
Now that we know how these bonds function, the next step is to understand their benefits and limitations.
Benefits and Limitations of Bullet Bonds
Benefits
- Predictable Income: Fixed coupon payments furnish a dependable cash flow schedule, suitable for income-focused investors.
- Capital Certainty at Maturity: The lump-sum principal repayment date is known from the moment of issuance. This enables precise planning for future liabilities.
- Non-Callable: Some bullet bonds are non-callable, which means the issuer cannot call back the bond until it matures. This provides certainty for the investor.
Limitations
- Interest-Rate Sensitivity: Bullet bonds exhibit full duration exposure until maturity; rising rates can cause significant price volatility for investors selling before maturity.
- Credit Event Risk: With no principal until the end, issuer default or downgrade before maturity can wipe out overall returns.
- Liquidity Constraints: Investors are not necessarily locked in until maturity. They can sell their bonds in the secondary market, but the liquidity of that market can be a limitation, making it difficult to sell quickly or at a favorable price.
Conclusion
Bullet bonds stand out for their simplicity, you know when your money will come back and in what form. For investors planning for major financial goals, that certainty is crucial.
That said, bullet bonds are not a complete solution on their own. They work best as part of a wider fixed income plan that balances cash flow, liquidity, and risk. Viewed this way, bullet bonds can give investors not just repayment of capital, but also greater clarity in planning ahead.
