Deferred interest bonds are bond issues that do not provide for periodic interest payments. Instead, the interest is paid to the bondholder at a specified point during the later maturity of the bond. This postponing of the interest payment may be shortly before the bond reaches maturity or be delayed until full maturity is achieved. One example of a deferred interest bond is known as the zero-coupon bond.
One of the main advantages of investing in a deferred interest bond is that the bonds are often available at significant discounts off the face value of the bond. This means that it is possible to enjoy a higher rate of return once the bond does reach maturity. In some cases, the return is not only realized because of the amount of interest accrued during the life of the bond, but also due to receiving the face value of the bond as the return on the principle.
Investors who wish to defer the reception of interest payments on bond issues also find the deferred interest bond approach to be very helpful. Because the interest is not scheduled to be paid until a certain date, it is easier to arrange finances in a manner that helps to minimize the taxes that become due once the interest payment is actually received. This is especially true if the principle and the interest are paid at the same time.
A deferred interest bond may also be a good investment, as the bond issue may carry a rate of interest that is very competitive with other types of bonds. The potential for earning a slightly higher rate of interest may prove to be attractive enough for the investor to forgo periodic interest payments and go with a lump sum interest payment late in the maturity process.
It is possible to locate deferred interest bond issues in just about any situation where bonds are issued. Municipalities may structure bond issues as a deferred interest bond. Companies who craft bond issues can also make use of the model, as the process of postponing the interest payments until a specific point in time makes it easier to set aside resources incrementally to meet the obligation.