What is an Income Bond?

An income bond is a bond that pays interest only if the issuing entity has earned income. This approach to interest payments differs from what is used for a conventional bond, where interest is due on an ongoing basis, irrespective of the earnings of the issuer.

The amount of interest paid may vary with the earnings of the entity, so investors are essentially participating in the earnings of the business. This also means that investors share in the risk of the issuer, since no earnings equates to no interest payments. Given the risk profile of an income bond, it is usually only issued by companies having significant financial difficulties (usually in bankruptcy reorganization), and it is bought by investors with a high tolerance for risk.

The interest paid by this type of bond can be tied to total entity earnings or to specific projects. If the bond terms indicate that interest is cumulative, then interest will accumulate during non-payment periods and be paid at a later date when income is available for doing so. Non-payment does not necessarily mean that the issuing entity is in default. A cumulative interest feature reduces the risk for the investor.