What it means
Most corporate and government bonds people encounter are bullets. The issuer pays a fixed coupon, often annually or semi-annually, and the full face value is returned on one specified day, which makes the cash flows simple to forecast and easy to compare across issues.
For the issuer, the attraction is low cash strain during the bond's life. Only interest has to be funded each period, which suits a company financing a long-lived asset or a project whose cash generation builds gradually.
The mirror image of that convenience is refinancing risk. The whole principal falls due on a single day, so the issuer must either have the cash available, be able to issue a replacement bond, or face default, and that risk is concentrated rather than spread.
Many bullet bonds are also non-callable, meaning the issuer cannot repay early. Investors like this because it locks in the yield for the full term, and the label "bullet" is often used loosely to mean exactly that: fixed coupons, fixed maturity, no early repayment and no amortisation.
Pricing follows directly from the shape. A bullet bond's price is the present value of the coupon stream plus the present value of the single principal repayment, and because so much of the value sits in that final payment, bullet bonds are more sensitive to interest rate changes than amortising bonds of the same maturity.
In practice
Real-world examples.
Example
A utility issues a $400,000,000 ten-year bullet bond at a 5% coupon to fund a new substation. It pays $20,000,000 of interest a year and plans to refinance the $400,000,000 principal with a fresh issue in year ten rather than repay it from operating cash.
Example
A pension fund buying bonds to match a known lump-sum obligation in 2038 prefers bullets over amortising bonds. The single maturity payment lines up with the single liability, whereas an amortising bond would return cash gradually and leave the fund with reinvestment risk.
Example
A treasury team compares a $60,000,000 bullet bond at 6% with a $60,000,000 amortising loan at 5.7%. The loan is cheaper on rate but repays $12,000,000 of principal each year, so the team chooses the bullet to keep annual cash outflow at $3,600,000 while a new factory ramps up.
Formula
Calculation
Price = (Coupon x annuity factor) + (Face value / (1 + yield) raised to the number of periods), where the annuity factor is (1 - (1 + yield) to the power of minus n) / yield. Take a 5-year bullet bond with a face value of $50,000,000 and an annual coupon of 6%. The annual coupon payment is $50,000,000 x 6% = $3,000,000, paid in each of years 1 to 5, with the $50,000,000 principal repaid in a single bullet at the end of year 5. Total coupons over the life are 5 x $3,000,000 = $15,000,000, the final year's cash flow is $3,000,000 + $50,000,000 = $53,000,000, and total cash paid by the issuer is $15,000,000 + $50,000,000 = $65,000,000. Now price it at a market yield of 7%. The annuity factor is (1 - 1.07 to the power of minus 5) / 0.07 = 4.1002, so the coupons are worth $3,000,000 x 4.1002 = $12,300,592. The discount factor for year 5 is 1 / 1.07 to the power of 5 = 0.7130, so the principal is worth $50,000,000 x 0.7130 = $35,649,309. The price is $12,300,592 + $35,649,309 = $47,949,901, a discount to the $50,000,000 face value because the 6% coupon is below the 7% yield investors require.Case study
Seen in the real world.
Thornlea Renewables is a fictional wind developer created for this illustrative example. It raised $50,000,000 through a 5-year bullet bond at a 6% coupon to build a wind farm that would take three years to reach full output. The bullet structure meant it paid only $3,000,000 a year in interest during the construction and ramp-up phase, when cash generation was minimal.
The board's error was assuming refinancing in year 5 would be routine. When the bond approached maturity, credit spreads had widened and the company found it could only refinance at 8.5%, which would have raised annual interest on a replacement $50,000,000 issue to $4,250,000, an extra $1,250,000 a year.
The treasurer avoided the squeeze by starting refinancing discussions eighteen months early and repaying $15,000,000 from accumulated cash, so only $35,000,000 needed to be refinanced. This illustrative story shows the central discipline of bullet bond financing: the low payments during the life are only affordable if the single repayment at the end has been planned for years in advance.
Watch out
Common mistakes.
- Assuming a bullet bond is safer because payments are small during its life, when the concentration of the entire principal on one date is precisely what makes refinancing risk high.
- Confusing a bullet bond with a zero-coupon bond, since a bullet still pays regular interest and only the principal arrives in one lump at maturity.
- Comparing a bullet bond and an amortising loan on headline interest rate alone, without modelling the very different cash outflow profiles across the years.
Questions
People also ask.
Why is it called a bullet?
Because the entire principal is repaid in a single shot at maturity rather than being spread across the bond's life in instalments.
Are all bullet bonds non-callable?
Not necessarily, though the term is often used to imply no early redemption, and any call feature will be set out explicitly in the bond's terms.
How does a bullet bond behave when interest rates move?
More sharply than an amortising bond of the same maturity, because a larger share of its value sits in the distant principal payment, giving it a longer duration.
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