Term Bond

Adviser Nkechi Balogun compares two new municipal issues from the same state. The Harrowgate Township issue repays a portion of its principal on each of the next twenty years. The Calderwood Authority issue repays no principal until a single date twenty years out, when the entire amount comes due. What is the correct classification, and what practical difference follows?

1. A.Harrowgate is a term issue and Calderwood is a serial issue, since Harrowgate makes payments in each of the twenty years.Incorrect and reversed. Repaying principal in instalments across many dates is the SERIAL structure; a single maturity date is the term structure.
2. B.Harrowgate is a serial issue and Calderwood is a term issue; term issues typically carry a sinking fund and trade as dollar bonds, while serial issues are quoted on a yield basis.Correct. The classification turns on the principal repayment schedule, and the quotation conventions follow from it.
3. C.Harrowgate must be a general obligation bond and Calderwood must be a revenue bond, because maturity structure determines the security pledged.Incorrect. The structures are commonly associated with those security types but do not determine them. Either pledge can use either structure.
4. D.The two are economically identical, since both repay the same principal over the same twenty-year period.Incorrect. Their cash flow timing, duration, reinvestment profile and quotation conventions all differ materially.

Why: The Harrowgate issue has a SERIAL maturity structure: a slice of principal matures each year, so the issue is really a package of bonds with staggered maturities and the issuer debt service stays comparatively level across the life of the issue. General obligation bonds supported by tax revenues are commonly structured this way. The Calderwood issue is a TERM issue: the whole principal falls due on one date, and issuers typically pair a term structure with a sinking fund into which money is deposited periodically so the balloon can actually be met at maturity. Revenue bonds financing a single large facility are frequently term bonds. The market conventions differ accordingly. Serial bonds are normally quoted on a YIELD basis with a separate yield for each maturity, forming a scale, while term bonds trade as dollar bonds quoted at a price.

A serial bond issue differs from a term bond issue in that a serial issue:

1. A.Matures all on one dateThis states the definition of a term issue, which is the structure the question is contrasting against. A serial issue deliberately spreads its maturities so the issuer retires the debt gradually.
2. B.Matures in installments over timeCorrect - staggered maturities.
3. C.Pays no interestPaying no interest describes a zero-coupon bond, a separate feature altogether. Serial and term describe the maturity schedule, and serial bonds carry ordinary coupons.
4. D.Never maturesA bond with no maturity at all is a perpetual instrument, which is the opposite of a serial structure. Serial issues do not merely mature; they mature repeatedly, on a schedule of dates.

Why: Serial bonds mature in staggered installments, while a term issue matures on a single date.