What is an Income Bond?

An income bond is a bond issue that is structured to only make interest payments when the issuing entity generates sufficient revenue to honor those payments. While there is no question regarding the repayment of the principal of the bond, income bonds may or may not generate any return at all. From this perspective, this type of bond is considered to be one of the riskier types of bond issues that can be used as an investment.

Bonds in general are configured to provide investors with some type of return for making an investment in a bond issue. Often, this is in the form of interest that is either paid to the investor at specific points during the life of the bond, or at the time that the bond reaches maturity. The rate of interest may be fixed or variable, depending on the terms related to the bond issue. In either case, the investor can reasonably look forward to earning an equitable return at some point in the future.

With an income bond, the possibility of not earning a return is increased somewhat. The terms and conditions of this type of debt security usually specify that the issuing entity must generate a certain level of revenue before it is obligated to make interest payments to the investor. In the event that the revenue generated in the period under consideration does not reach that minimum level, the investor will receive no return for that period.

While carrying a greater risk, it is not unusual for an income bond to offer a slightly higher rate of interest to the investor. In situations where a company is attempting to recover from a financial setback and avoid bankruptcy, issuing bonds of this type is an excellent alternative. Should the investor believe that the company issuing the income bond has an excellent chance of recovering and generating at least the minimum amount of revenue necessary to trigger interest payments, the deal may be considered worth the risk.

Before actually purchasing an income bond, it is important to look closely at the terms of the bond agreement. A income bond carrying a variable rate of interest may include some type of tiered schedule for issuing interest payments, providing the investor with some idea of what type of return to expect, based on the current average rate and the level of revenue generated by the issuer. The terms may also document what happens if the issuer does not generate enough income to require the issue of an interest payment in one period of the bond, but does in a subsequent period. Knowing what could happen as the worst case scenario, as well as determining the potential return, will help the investor decide whether or not to actually purchase the income bond.