Commodity-Backed Bond
What Is a Commodity-Backed Bond?
A commodity-backed bond is a type of debt security where the coupon payments or potentially principal is straightforwardly linked to the price of the underlying commodity.
Understanding Commodity-Backed Bonds
Most bonds have a fixed value determined at the hour of purchase. This value is a combination of the bond's face value and its interest rate (coupon), the two of which are set at the hour of issue. Commodity-backed bonds are issued where either the interest payments or the face value can shift with the price of the underlying commodity.
Consequently, a commodity-backed bond will experience vacillations in value when the price of the underlying commodity rises or falls. The bond's issuer determines how the bond's value will change with the price of the commodity. For instance, the issuer could tie a gold-backed bond's principal to $1,000 or the market price of one ounce of gold, whichever is higher at maturity.
Beside giving the bondholder with a consistent source of income, commodity-backed bonds have the additional fascination of being a speculative vehicle for investors who accept that the price of the underlying commodity will rise. Moreover, commodity-backed bonds are habitually used to hedge against inflation.
Commodity-backed bonds will generally have maturities longer than five years. Classified as long-term liabilities, these bonds act as important sources of financing to the companies that issue them. Commodity-backed bonds normally pay a lower coupon rate than customary bonds, since the investor can possibly earn more if, or when, the commodity gains value.
Commodity-backed bonds are generally issued by the companies that produce the associated commodity. Models incorporate bonds linked to oil, gold, and coal. Besides, commodity-backed bonds typically have a call option associated, which permits the issuer to reclaim the issue prior to maturity. This feature safeguards the issuer from excessively large payments to investors if the commodity's price goes up fundamentally.
Commodity-Backed Bond Risk
Commodities can be very unstable, and that means that their prices can vary a great deal. Subsequently, a commodity-backed bond generally conveys a higher degree of risk for the investor than do normal bonds. Customary bonds generally appeal to investors who need a predetermined yield with practically zero risk. Commodity-backed bonds don't offer this safety. All things considered, they appeal to investors interested in speculating, who will carry a degree of risk. If the commodity loses value, the bondholder might see their bond's coupon rate or face value fall, reducing their overall yield.
Features
- Commodity-backed bonds are debt securities where the price of an underlying commodity straightforwardly impacts the coupon payments and additionally principal.
- Since investors can possibly earn more on the off chance that the commodity gains value, commodity-backed bonds typically pay lower coupon rates than customary bonds.
- Not exclusively can commodity-backed bonds give bondholders a consistent source of income, however they can likewise be a productive vehicle for investors who hypothesize that the price of the commodity will rise.
