Baby Bonds

What are Baby Bonds?

Baby Bonds are defined as debt instruments issued in the small denomination (usually $25 face value against the normal $1000 face value of bonds) and mostly unsecured and tradable on exchanges.  These fixed-income securitiesFixed-income SecuritiesFixed income investment is a type of investment in which the investor receives a fixed and relatively stable stream of income in the form of dividends or interest over a period of time. Companies and governments typically issue fixed investments in the form of debt securities.read more attract the fancy of Retail Investors who were not able to invest much in larger denomination bonds. Baby bonds are issued by a wide array of issuers, including corporate, state governments, municipalities, etc. to fund projects with long gestation periods and heavy capital expenditureCapital ExpenditureCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year.read more requirements.

Baby Bonds are normally issued as zero-coupon bondsZero-coupon BondsIn contrast to a typical coupon-bearing bond, a zero-coupon bond (also known as a Pure Discount Bond or Accrual Bond) is a bond that is issued at a discount to its par value and does not pay periodic interest. In other words, the annual implied interest payment is included into the face value of the bond, which is paid at maturity. As a result, this bond has only one return: the payment of the nominal value at maturity.read more, which means they are issued at a discount to their par value, and usually, companies with small issue sizes come up with such issues to ensure enough liquidity due to the small ticket size of these bonds.

In short, Baby Bonds are unsecured bond offerings that enable small retail investors to invest a small sum of money and reap the benefits of investing in bonds without the need for investing big sums of money, which are normally required for normal bonds.

Example of how Baby Bonds Work

Let’s understand Baby Bonds with the help of a few hypothetical examples:

Jason is interested in diversifying his portfolio by investing a portion of his investments in bondsInvestments In BondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more; however, he wants to keep his investment limited up to $1000. He has two options:

  • Option 1: Invest in a single bond of the face value of $1000.
  • Option 2: Invest in baby bonds of a utility company that offers baby bonds in a small denomination of $50 and offers a high yield and invest in the municipal bond of face value $500, thereby obtain diversification benefits as well.

Thus Baby Bonds offer Jason to enjoy diversification, high yield even with less investment. However, it is pertinent to note that these benefits come with an additional risk in the form of Unsecured Nature, less liquidity compared to traditional bonds that come along with Baby Bonds.

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Source: Baby Bonds (wallstreetmojo.com)

Baby Bonds in the US

These bonds have their origin in the US. The first Baby Bonds started in the US in 1935 when the then President Franklin D. Roosevelt created the Baby Bond Program to encourage the habit of saving among the American Population and channelizing of those savings for financing government development programs which are long term in nature. However, now they are issued by Municipalities, Corporations to finance their long term projects.  These Bonds are tax-exempt in the United Kingdom.

It recently got a lot of attention when Democratic Presidential Candidate for the next year Presidential Elections in the USA, Cory Booker, put up the Baby Bond Proposal under which government would provide every child born in the USA with a $1000 initial contribution and  $2000 additional contribution year on year till the child attains adulthood based on the family Income and as per estimates due to this Baby Fund contribution kids belonging to the richest families will get a contribution to the tune of $1700 while those belonging to the poorest families can gain up to $46000 which can be used for their higher studies and retirement needs.

Advantages of Baby Bonds

Disadvantages of Baby Bonds

Just like a Financial Instrument, Baby Bonds also have a lot of Disadvantages, few of them are enumerated below:

Important Points

  • These bonds are normally issued with the face value of $25 to $500, however mostly in the denomination of $25.
  • The maturity of this bond varies from a minimum of 5 years and can extend up to 84 years ( as per the listed baby bonds available in the market).
  • These bonds are mostly callable at the option of the issuer, which in any case, will not be less than five years from the date of issue.
  • Baby bonds are always unsecured and offer a high yield compared to normal bonds due to the additional risk and callable feature that is advantageous to the issuer.

Conclusion

Baby Bonds are exchange-traded debt that enables small investors to reap the benefits of investing in bond instruments with a face value as low as $25 and also allow companies with small issue size to easily float there bond issue and at the same time, ensure sufficient liquidity. Baby Bonds, just like any other financial instruments, has its pros and cons, an investor should keep these points in mind before making their investments.

This has been a guide to what are baby bonds and its definition. Here we discuss an example to understand how baby bonds work with its advantages and disadvantages. You can learn more about financing from the following articles –

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