Key Takeaways
- Baby bonds are fixed income securities with par values under $1,000, appealing to individuals without a lot of money to invest.
- Municipal, county, and state governments issue baby bonds, often as zero-coupon bonds with long maturities, to fund infrastructure projects.
- Companies may issue baby bonds to generate demand and liquidity, especially when large debt offerings are not feasible.
- Baby bonds are unsecured debt, so bondholders are typically paid after secured debt holders, but prioritized over preferred and common stockholders.
- Callable baby bonds may be redeemed early, offering higher coupon rates to compensate for potential early repayment risks.
What Is a Baby Bond?
A baby bond is a fixed income security that is issued in small-dollar denominations, i.e., with a par value of less than $1,000. Baby bonds’ small denominations enhance their appeal for individual investors without the funds to invest in traditional bonds with larger par values.
Exploring the Benefits and Risks of Baby Bonds
Baby bonds are issued mainly by municipalities, counties, and states to fund expensive infrastructure projects and capital expenditures. These tax-exempt municipal bonds are generally structured as zero-coupon bonds with a maturity of between eight and 15 years. These municipal bonds usually have an A rating or better in the bond market.
Businesses also issue baby bonds as corporate bonds. These businesses include utility companies, investment banks, telecom companies, and business development companies (BDCs) that fund small- and mid-sized businesses. The price of the corporate bonds is determined by the issuer’s financial health, credit rating, and available market data for the company. Companies may issue baby bonds to create demand and liquidity if they can’t or don’t want to make large debt offerings. Companies also use baby bonds to attract small investors who can’t afford the standard $1,000 bond.
Practical Example of Baby Bond Issuance
For example, an entity that wanted to borrow money by issuing $4 million worth of bonds might not garner much interest from institutional investors for such a relatively small issue. In addition, with a $1,000 par value, the issuer will be able to sell only 4,000 bond certificates on the markets. However, if the company issues baby bonds instead for a $400 face value, retail investors will be able to affordably access these securities, and the company will have the capacity to issue 10,000 bonds in the capital markets.
Key Considerations When Investing in Baby Bonds
Baby bonds are usually unsecured debt, meaning no collateral is pledged to ensure payment if there’s a default. If the issuer defaults, baby bondholders only get paid after secured debt holders. However, baby bonds are senior to a company’s preferred shares and common stock.
Baby bonds can be callable, meaning the issuer can redeem them before maturity. When bonds are called, the interest payments also stop being paid by the issuer. To compensate baby bondholders for the risk of calling a bond prior to its maturity date, these bonds have relatively high coupon rates, ranging from around 5 percent to 8 percent.
Different Types of Baby Bonds Around the World
Baby bonds may also refer to a series of small-denomination savings bonds with face values ranging from $75 to $1,000, issued by the U.S. government from 1935 to 1941. These tax-exempt bonds were sold at 75% of face value and had a maturity of 10 years.
In the UK, baby bonds refer to a type of bond launched in the late 1990s with the objective of encouraging savings for children by their parents. Parents had to make small monthly contributions for at least 10 years, and in return, the child received a guaranteed minimum amount tax-free upon turning 18.
The Bottom Line
Baby bonds are fixed income securities with a face value of less than $1,000, typically aimed at attracting retail investors. Baby bonds are often issued by municipalities and corporations, including businesses like utility companies and telecom firms, to enhance liquidity and to fund infrastructure projects and capital expenditures. Although baby bonds are usually unsecured debt, bondholders get priority over preferred and common share stockholders in the event of a default. Investors interested in buying baby bonds should evaluate the issuing entity’s financial health and risk profile, just as they would for traditional bonds.