What Is an Amortized Bond? How They Work, and Example

An amortized bond is a type of debt security that is repaid in regular installments over a set period of time. The term "amortization" refers to the process of paying down the principal balance of a loan over time. With an amortized bond, the borrower makes regular payments that include both interest and principal. The interest payments are typically fixed, while the principal payments increase over time as the loan balance decreases.

Amortized bonds are often issued by governments and corporations to finance large projects. They are also popular with investors because they offer a predictable stream of income. The interest payments on an amortized bond are typically higher than the interest payments on a similar non-amortized bond. This is because the borrower is paying down the principal balance of the loan over time, which reduces the overall risk to the investor.

There are two main types of amortized bonds: level-payment bonds and sinking-fund bonds. With a level-payment bond, the borrower makes equal payments over the life of the loan. The interest payments on a level-payment bond are fixed, while the principal payments increase over time. With a sinking-fund bond, the borrower makes regular payments into a sinking fund. The sinking fund is used to purchase bonds that are then retired. The interest payments on a sinking-fund bond are typically lower than the interest payments on a level-payment bond. This is because the borrower is paying down the principal balance of the loan more quickly.

Here is an example of how an amortized bond works. Suppose a company issues a $100,000 bond with a 5% interest rate and a 10-year term. The company will make 10 equal payments of $12,500 each. The first payment will consist of $5,000 in interest and $7,500 in principal. The second payment will consist of $4,750 in interest and $7,750 in principal. The third payment will consist of $4,500 in interest and $8,000 in principal. And so on.

Amortized bonds are a popular choice for investors because they offer a predictable stream of income. They are also a good choice for borrowers because they allow the principal balance of the loan to be paid down over time.