What are baby bonds?
A baby bond is a fixed income security issued in small denominations, with a face value of less than $1,000. Small denominations make baby bonds more attractive to ordinary retail investors.
- A baby bond is a bond with a face value of less than $1,000.
- These small-denomination bonds are designed to appeal to ordinary investors who may not have a lot of money to invest in traditional bonds.
- Baby bonds are most common among municipal issuers, or as government-issued savings bonds.
Learn about baby bonds
Baby bonds are primarily issued by cities, counties and states to finance expensive infrastructure projects and capital expenditures. These tax-exempt municipal bonds are typically structured as zero coupon bonds with maturities ranging from 8 to 15 years. Municipal bonds are typically rated A or higher on the bond market.
Baby bonds are also issued by corporations as corporate bonds. Corporate issuers of these debt securities include utilities, investment banks, telecommunications companies and business development companies (BDCs) involved in funding small and medium-sized businesses. The price of corporate bonds depends on the issuer’s financial condition, credit rating and market data available to the company. Companies that cannot or do not want to issue large bonds may issue baby bonds to generate demand and liquidity for the bonds. Another reason companies issue baby bonds is to attract small or retail investors who may not have the funds to buy the standard $1,000 bond.
For example, an entity that wants to borrow money by issuing $4 million worth of bonds may not attract much interest from institutional investors for such a relatively minor issue. Additionally, at a face value of $1,000, the issuer will only be able to sell 4,000 bond certificates in the market. However, if the company were to issue baby bonds at a face value of $400, retail investors would be able to obtain these securities at an affordable price, and the company would be able to issue 10,000 bonds in the capital markets.
Baby bonds are generally classified as unsecured debt, which means that the issuer or borrower does not commit any collateral to guarantee the payment of interest and principal repayment in the event of default. Therefore, if the issuer defaults on its payment obligations, the baby bondholders will only be paid after the secured debtholder’s claims have been satisfied. However, under the standard structure of debt instruments, baby bonds have priority over a company’s preferred and common stock.
One feature of baby bonds is that they are callable. A callable bond is a bond that the issuer can call early, i.e. before maturity. When the bond is called, the issuer also stops paying interest. To compensate baby bondholders for the risk of redeeming the bonds before maturity, the bonds carry relatively high coupon rates ranging from 5% to 8%.
other baby bonds
Baby bonds may also refer to a series of small-denomination savings bonds with denominations ranging from $75 to $1,000 issued by the US government between 1935 and 1941. These tax-exempt bonds are sold at 75% of face value and have a maturity of 10 years.
In the UK, a baby bond refers to a bond introduced in the late 1990s to encourage parents to save for their children. Parents must make small monthly contributions for at least 10 years, and in return, the child receives a guaranteed minimum tax-free amount at age 18.