VPS | Types of Bonds Worldwide

Structured Bonds

Structured bonds are one of the financial instruments that have seen significant development in recent decades. They involve the incorporation of derivative products into investment instruments to create new products that cater to diverse customer needs. Structured bonds allow investors to access various types of risks within a single product (credit risk, interest rates, exchange rates, stock prices, commodity prices), unlike traditional bonds. The cash flow of structured bonds depends on the fluctuations of risks associated with the product.

In essence, structured bonds consist of a corporate bond combined with one or more derivative products such as options contracts, swap contracts, or futures contracts.

Floating Rate Notes (FRN)

Floating rate notes are one of the simplest forms of structured bond products. The interest rate is determined based on a common reference in the market such as LIBOR or government bond yields. The interest rate is periodically adjusted, and at the beginning of each period, the bond is traded around its nominal value.

Inflation-Linked Bonds

Inflation-linked bonds are among the earliest structured products designed to help investors hedge against inflation risk. These bonds ensure that investors receive a return higher than the inflation rate during the bond's investment period, thus guaranteeing a positive real interest rate. This is particularly important as interest rates during inflationary periods tend to increase to curb inflation.

Inflation-linked bond products are issued by governments rather than investment banks. Governments of some developed countries such as the US, UK, France, Canada, Japan, and Sweden issue inflation-linked bonds. The largest in terms of value are the US government's inflation-linked bonds with circulating values of $500 billion and the UK government's inflation-linked bonds with circulating values of over $300 billion.

Currency-Linked Bonds

Currency-linked bonds, or foreign exchange-linked bonds, are structured products where the interest rate is dependent on the exchange rate movements of a currency pair. Essentially, currency-linked bonds include a corporate bond with a forward foreign exchange contract (cash-settled) structured within the bond.

Instead of purchasing corporate bonds and forward foreign exchange contracts separately, investors can request the issuance of currency-linked bonds. In essence, investors bear two risks: the credit risk of the bond and the potential losses from foreign exchange trading. Therefore, the bond's coupon is structured to reflect the profitability correlation with these underlying risks.