Bunny Bond
What is Bunny Bond?
A bunny bond is a type of bond that offers investors the option to reinvest coupon payments into extra bonds with a similar coupon and maturity.
Understanding Bunny Bond
Bunny bonds are otherwise called guaranteed coupon reinvestment bonds and are a type of multiplier bonds. Basically, an investor has the option of buying extra debt with the coupon payments or receive it as cash.
With a bunny bond, investors can recycle and change dividend payments to secure another investment. The initial bond agreement incorporates a clause that gives the bondholder the option, assuming they ought to decide to exercise it, to reinvest their coupon payments. This is an alluring provision for investors, as it provides them with a kind of safety net or backup plan that can offer a significant recourse in the event that they face the possibility of assuming a loss as a lower interest rate.
This potential loss addresses what is known as reinvestment risk. This is the possibility that a bond's subsequent future coupons won't be reinvested at the interest rate in effect when the bond was initially purchased. Assuming that interest rates decline, that would mean a downgrade when the reinvestment happens. This reinvestment risk will be all the more a factor when interest rates are going down.
Bunny Bonds and Reinvestment Risk
Bunny bonds are an effective method for safeguarding against reinvestment risk, which emerges from the possibility that interest rates will drop from now on. This reinvestment risk will affect the bond's yield to maturity (YTM), since this is calculated in light of the assumption that future coupon payments will be reinvested at the overarching interest rate when the bond was initially purchased.
With a normal bond, investors are presented to the risk of having to reinvest their coupons at a lower interest rate. Hence, investors are not genuinely secure with any confirmations that they are guaranteed to earn the yield, since they must account for the coupon reinvestment risk. One method for keeping away from this unfortunate scenario is to reinvest coupon payments in extra bonds with similar coupon and maturity, which they can do on the off chance that they have a bunny bond.
In the event that an investor decides to reinvest all cash coupons back into the bond they are as of now holding, it acts in basically the same manner to a zero-coupon bond, as the investor receives no cash flow until maturity. A zero-coupon bond is a debt instrument that doesn't pay interest, known as a coupon, however is offered at a critical discount. Hence, the investor procures a profit when the bond arrives at maturity and can be reclaimed for its full face value.
Features
- Bunny bonds are otherwise called guaranteed coupon reinvestment bonds.
- A bunny bond is a type of bond that offers investors the option to reinvest coupon payments into extra bonds with a similar coupon and maturity.
- Bunny bonds are an effective method for safeguarding against reinvestment risk.
