What are Bearer Bonds?

Bearer bonds are a unique type of debt security that does not carry the name of the bondholder on the records. As the name suggests, the bearer (the person who owns the bond) of the bond is considered to have ownership of the bond. They are also called ‘coupon bonds’ because upon submitting the coupon attached to the bond, the bearer receives a fixed interest payout. These fixed-income securities are issued in the physical form and ownership can easily be transferred by passing the bond from one person to another.

Bearer bonds offer complete anonymity to the holder, unlike modern forms of securities that require registration. However, due to concerns over transparency and changes in Indian financial regulations, bearer bonds have become extremely rare. In this article, we will help you understand what bearer bonds are with an example, and share with you the benefits and drawbacks of this type of debt instrument.

Key Highlights

• Bearer bonds are debt securities where ownership of the bond depends upon the physical possession of the bond. 

• This type of bond is preferred because it offers anonymity, ease of transfer, and flexibility as it can be purchased without having to register with any authority. 

• Bearer bonds are vulnerable to theft as the ownership transfer is as easy as handing over the bond to the buyer. 

• Most countries now prefer more registered financial instruments that provide accountability and transparency due to the risks and vulnerabilities involved in bearer bonds.

Understanding Bearer Bonds

When an investor invests in a regular bond, the name of the investor is mentioned on the bond certificate. The investor receives the periodic amount in the registered account during interest payment. Post maturity, the principal amount is paid back to the bondholder. The whole process is currently done electronically and each transaction is overseen by a regulatory body (Securities and Exchange Board of India – SEBI). However, in the case of bearer bonds, the systems are different. 

Upon investing in bearer bonds, the investor receives a physical bond certificate from the issuer (government or non-government entity). ‘Coupons’ are attached to the certificate that specify the interest rate and the date at which the investor would receive interest payments. The investor must physically detach these ‘coupons’ in order to encash his interest payments. Post-maturity date, the bondholder will receive the principal amount after the bond certificate is physically submitted to the issuer or the paying agent. 

The main advantage of bearer bond is the “no-record” feature. Unlike regular bonds that maintain a record and pay the interest directly to the bondholder, bearer bonds rely on physical possession. 

Features of Bearer Bonds

Some of the features of bearer bonds are mentioned below.

• Anonymity: The bondholder’s name is not registered or mentioned in the bond certificate.
• Physical Possession: The bondholder must have a physical certificate with coupons attached to be able to redeem the principal amount and the interest payment.
• Easy to Transfer: Since no name is mentioned on the certificate and no record is maintained of the investor, bearer bonds can easily be transferred by handing over the certificate to the buyer. 
• Interest Payments: To receive periodic interest payments, the investor must physically detach the coupons from the bond certificate and hand them over to the issuer or the payment processing entity. 

Example of Bearer Bonds

Let us understand the concept in simple terms with the help of an example. 

Assume that there is a company called ABC. To meet its capital requirements, the company issues bearer bonds and prints bond certificates worth Rs. 10,000 each. The maturity period of these bonds would be 5 years with an annual interest rate of 5%. Each bond has coupons attached to it which represent the interest payment due over five years. 

This means that if an investor buys one of these bonds, he would be entitled to an annual interest payment of Rs. 600 (6% of Rs. 10,000). To collect these payments, the investor would actually detach the coupons and submit them to the issuer or the paying agents. After five years, the investor would receive his principal amount of Rs. 10,000 upon presenting the bond certificate. 

Now let’s say that the investor wants to realign his investments and thus wishes to sell the bonds. All he has to do is find a buyer for his bonds and hand over the bond certificate that consists of the remaining interest payment coupons. In return, the investor would receive his principal amount. No need to register the bond or notify the issuer. Ownership of the bearer bonds changes simply by transferring the bond. 

Due to their level of anonymity and lack of paperwork, bearer bonds are favoured by a large audience. Let us now look into more benefits of bearer bonds. 

Benefits of Bearer Bonds

While bearer bonds are not popular in India and are even extinct in the U.S., they offered several benefits that attracted investors. Some of the advantages of bearer bonds are mentioned below.

• Anonymous Nature

One of the reasons bearer bonds are highly preferred is because of the high level of privacy they offer. While buying a bearer, the investor does not have to register himself with the issuer or the government. This allows people to invest large amounts of money without leaving a paper trail. It is this feature of bearer bonds that makes it attractive to people who value confidentiality. 

• Easily Transferable

If an investor wishes to sell his bonds, all he has to do is physically hand over the bond certificate. Transferring wealth between businesses or individuals without having to go through legal or financial intermediaries became easy because of this feature of the bearer bonds. 

• Non-Traceable

Since the issuing company or the government did not keep a record of the purchase, there were no reporting requirements linked to the ownership of these bonds. For this reason, bonds were often used for international transactions, inheritance planning, or in situations where the investors wanted to move money across borders. For a long time, they were also useful for investors in diversifying their assets privately. 

• Fixed-Interest Payments

Like every other bond type, bearer bonds also offer a fixed interest payment and a promise of principal repayment on maturity. 

Disadvantages of Bearer Bonds

The investing world runs by the quote: The greater the risk, the greater the reward. And because bearer bonds are also a type of investment, their huge rewards come with huge risks and various disadvantages. It is because of these disadvantages that the government has issued stricter regulations towards their issuance. Let us see what are the risks/disadvantages of bearer bonds. 

• Risk of Theft or Loss

Any investment that includes physical possession has the risk of theft attached to it. Similar is the case with bearer bonds. If an investor loses the bond certificate due to theft or manmade/natural disasters, there is no way he would be able to recover the lost value. Since there is no registration, the new owner of the bond will be entitled to the principal and interest payments. 

• Challenging During Dispute Resolutions

Resolving a dispute on the grounds of bearer bond ownership is difficult for courts and law enforcement since there are no records of bondholders. This means if the investor loses the bond certificate and some other party finds it, the ownership of the bond would automatically be transferred to that party. 

• Difficulty in Claiming Interest and Principal Payment

Bearer bonds have ‘coupons’ attached to them. The investor has to manually submit these coupons to receive the interest payment. If the investor loses the coupons or the bond certificate, he will not be entitled to his share of the amount. This would defeat the whole purpose of his investments.

• Lack of Traceability

It is challenging for issuers and regulators to monitor investments since there is no registration done when an investor invests in a bearer bond. Furthermore, this hindered the government’s tax collection efforts. 

Conclusion

Bearer bonds, an asset that offers a unique way to invest in fixed-income securities, have fallen out of favour due to the risks attached to them. They have also lost popularity due to the rise of more secure and regulated alternatives. While they offer the benefit of anonymity and ease of transfer, these benefits are outweighed by the disadvantages of bearer bonds. Due to drawbacks like the risk of theft and lack of traceability, investors are shifting to registered bonds and other more secure types of investments.

FAQs on Bearer Bonds