Finance
Fact-checked

At SmartCapitalMind, we're committed to delivering accurate, trustworthy information. Our expert-authored content is rigorously fact-checked and sourced from credible authorities. Discover how we uphold the highest standards in providing you with reliable knowledge.

Learn more...

What is a Commodity-Backed Bond?

A commodity-backed bond is an innovative financial instrument where its value is secured by a tangible commodity, like gold or oil, rather than solely by the issuer's creditworthiness. This fusion of physical assets with investment products offers a hedge against inflation and currency fluctuations. Curious about how this could diversify your portfolio? Let's delve deeper into the world of commodity-backed bonds.
Malcolm Tatum
Malcolm Tatum
Malcolm Tatum
Malcolm Tatum

Commodity-backed bonds are bonds with a connection to the current price of the underlying commodity that is used to guarantee the value of the investment. This is different from the practice with other types of bonds, where the value of the bond is determined by the fixed dollar amount offered at the time the bond is purchased. Generally, a commodity-backed bond is understood to function as a hedge against the possible swing of the economy into a period of inflation.

Sometimes referred to as a gold bond, the commodity-backed bond has the potential to generate more of a return than most other types of bonds. The key to the rate of return has to do with the current market value of the commodities that back the bond. In the event that the commodity performs at a higher level than anticipated at the time the bond is purchased, the investor will receive higher interest payments and/or a higher repayment on the principle investment.

Man climbing a rope
Man climbing a rope

Because the commodity-backed bond does carry more potential to generate a higher return than a fixed rate bond, there is also more risk involved. While it is unusual, there is always the possibility that the underlying commodities will not perform as anticipated and the return will be less than originally projected. However, most investors consider the degree of risk to be well worth the potential return. In general, a commodity-backed bond tends to carry less volatility than many stock issues.

In many cases, the commodity-backed bond is issued by businesses that have a vested interest in the commodity that is used to back the bond. Since the purpose of the bond issue is to generate revenue and also be able to depend on investors coming back for subsequent bond issues, firms tend to be very realistic about the use of commodities to back the bonds. For this reason, the commodity-backed bond is rarely backed with a commodity that is anticipated to be impacted by an economic recession during the life of the bond.

Malcolm Tatum
Malcolm Tatum

After many years in the teleconferencing industry, Michael decided to embrace his passion for trivia, research, and writing by becoming a full-time freelance writer. Since then, he has contributed articles to a variety of print and online publications, including SmartCapitalMind, and his work has also appeared in poetry collections, devotional anthologies, and several newspapers. Malcolm’s other interests include collecting vinyl records, minor league baseball, and cycling.

Learn more...
Malcolm Tatum
Malcolm Tatum

After many years in the teleconferencing industry, Michael decided to embrace his passion for trivia, research, and writing by becoming a full-time freelance writer. Since then, he has contributed articles to a variety of print and online publications, including SmartCapitalMind, and his work has also appeared in poetry collections, devotional anthologies, and several newspapers. Malcolm’s other interests include collecting vinyl records, minor league baseball, and cycling.

Learn more...

You might also Like

Discuss this Article

Post your comments
Login:
Forgot password?
Register:
    • Man climbing a rope
      Man climbing a rope