Key Takeaways
- Bearer bonds are rare debt instruments requiring a physical bond certificate for redemption.
- Bearer bonds were once a popular form of debt financing because they were easy to transfer between parties and required minimal administrative effort following issuance.
- Their use has declined dramatically in recent decades, largely due to the fact the lack of registration invites theft, money laundering, tax evasion, terrorism financing and other criminal behaviors.
- Today, they are nearly extinct in the U.S. and other advanced countries. They have been replaced by registered bonds, whose ownership is recorded in a central database and transferred electronically.
What Are Bearer Bonds?
A bearer bond is a debt instrument issued by a company or a government body to investors to finance a variety of initiatives. The physical holder (or bearer) of the bond certificate and attached coupons, not a registered owner, is the owner of the instrument and can claim its cash flows.
To obtain interest payments stipulated by a bearer bond, you must furnish the coupons to the issuer (or an agent specified by the issuer). Likewise, to redeem the bond at maturity, you must furnish the bond certificate.
This is very different from the arrangement associated with a registered bond, which is characterized by electronically documented owners. A registered bond’s coupons are payable to the registered owners, as is the bond’s principal amount upon maturity.
Moreover, when someone sells a registered bond in the secondary market, the listed owner is updated and the new owner receives the rights to the bond’s cash flows. Incidentally, people can also buy and sell bearer bonds in the secondary market.
Bearer bonds are unique in that the physical holder can claim their cash flows. It’s important to understand the process of redeeming these bonds and to determine whether they are still used today.
Timothy Li, MBABusiness Finance ManagerTimothy Li, MBA, has dedicated his career to increasing profitability for his clients, including Fortune 500 companies. Timothy currently serves as a business finance manager where he researches ways to increase profitability within the supply chain, logistics and sales departments.
How Do Bearer Bonds Work?
A simple example can help illustrate how bearer bonds work. Assume the following:
- You purchase a $10,000 bearer bond issued by the Old Times Corporation on January 1, 2024.
- The bond has a 10-year term with a maturity date of January 1, 2034, and an annual coupon rate of 6.00%.
- Coupon payments are scheduled to be paid quarterly on Jan. 1, April 1, July 1 and Oct. 1, with the first payment scheduled for April 1, 2024.
Based on the information above, you can expect the following quarterly coupon payment:
Quarterly Coupon Payment = Bond Par Value × Coupon Rate ÷ Number of Payments per Year
Quarterly Coupon Payment = $10,000 × 6.0% ÷ 4 = $150
Annualized, this produces $600 of interest income. If you hold the bond to maturity, you can expect to be paid $6,000 of interest over the 10-year term, along with the return of your initial $10,000 investment on Jan. 1, 2034.
However, to claim the periodic interest payments, you must clip each coupon and present it to the issuer or registered agent on or after each scheduled payment date. Likewise, to redeem the bond, you must present the bond certificate to the issuer or registered agent at maturity.
Do Bearer Bonds Exist in the U.S.?
Today, bearer bonds are nearly extinct in the U.S. and other advanced countries, largely because the lack of registration invites theft, money laundering, tax evasion, terrorism financing and other nefarious behaviors.
Government bodies and corporations in the U.S. widely issued bearer bonds between the late 19th century and the late 20th century. They were a popular form of financing because they were easy to transfer between parties and required minimal administrative effort following issuance. However, their use has declined dramatically in recent decades.
After the Tax Equity and Fiscal Responsibility Act of 1982, the U.S. government ceased issuing bearer bonds and took steps to require existing bearer bonds to be changed to registered bonds. Other developed nations have largely followed suit.
Bearer bonds are still legally traded in the U.S., but regulatory and law enforcement agencies keep a close eye on issuances and transfers of these instruments to curb illegal activity. To facilitate the oversight, financial institutions must adhere to rigorous know your customer (KYC) and anti-money laundering (AML) protocols when dealing with bearer bonds.
Read More: Alternatives to Bonds
Redeeming Old Bearer Bonds
U.S. bearer bonds are extremely rare, but every year there are instances of bondholders seeking to cash in coupons and redeem the principal on instruments with long-expired maturity dates. Collecting the cash flows from instruments issued by the U.S. Treasury is fairly easy and entails following their instructions to redeem old bearer bond payments.
Collecting the cash flows from instruments issued by corporations is not as easy and far from guaranteed. In 2010, U.S. law relieved banks and brokerages of the responsibility to honor bearer bond coupon payments and redemptions. If you find a corporate bearer bond, you can check to see if the company still exists or was taken over by another entity. By contacting the surviving company, you may be able to cash in the outstanding coupons and principal. To streamline the process, consult with a fiduciary financial advisor.
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