Plain Vanilla Bonds

  Key Point
Plain vanilla is the basic version of a financial instrument without any special feature. Plain Vanilla Bonds are the basic bond with a low-risk profile.

Bonds are financial instruments used to raise debts from the available market. Among the most frequent forms of bonds would be plain vanilla bonds. These are the most basic bonds. Going by the title, if 100 customers go to an ice cream store, most of them would dictate vanilla flavoured ice cream. Further, many of them would need extra flavour added to vanilla.

Thus, we predict the bond together with basic features and desired with all as plain vanilla bonds. Under plain vanilla bonds, fixed coupon payments are determined at regular intervals with a pre-determined maturity date.

Liquidity at Plain Vanilla Bonds

Plain vanilla bonds are essentially the standard bonds with large issues in which the trade can be done with very tight spread. They are tight and easy to trade.

These bonds also have an adequate selection and take care of the industry position. Exotic bonds have reduced liquidity leading to higher spreads and enable more risky offerings. The investors can benefit heavily from plain vanilla bonds issued by highly rated companies as AA or AAA-rated ones. Liquidity is the key in any marketplace and Plain vanilla bonds are king in the section.

Example of Plain vanilla bonds

A 5-year bond that pays 10 percent annual coupon rate (payment semi-annually) with the face value of $100. Therefore, in this plain vanilla bond.

Coupon Rate = 10% of $100 = $ 10 Each Year

Time of voucher payments = semi-annually = $ 5 every 6 months ($ 10/2)

There are many features which can be made within this simple vanilla bond according to issuer’s or investors requirement.

Features of Plain vanilla bond

Coupon prices and tenure and time of voucher payments have been fixed. Maturity is pre-determined at the time of issue.
All these are extremely straightforward bonds and comes with standard terms and conditions on the market.

Bonds can have fixed coupon rates, zero prices or can be nature of step-up bonds. Under plain vanilla bonds, this isn’t particularly the situation. The plain vanilla bonds coupon rate stays constant throughout the life of the bond.

Characteristic of callable/puttable

In plain vanilla callable bonds, the issuer has a right to call the bond before the date of maturity. While in the event of puttable plain vanilla bonds, the investor has the right to redeem the bond prior to maturity. The date of maturity hence becomes flexible in a variety of bonds. This is not true of plain vanilla bonds where the date of maturity is fixed and cannot be changed.

Bonds frequently includes convertible option meaning they can be converted into equity shares or preference shares at a predetermined date. A plain vanilla bond isn’t convertible. It has to be redeemed at the date of maturity and it cannot be converted into another kind of security.

Benefits of Plain vanilla bond

Simple valuation computation
To appreciate a financial tool, the money flow shall be projected over the life of that instrument. The money flows in plain vanilla bonds are fairly straightforward as they’re just the normal payment till the date of maturity. Such simple money flow computation makes the evaluation of plain vanilla bonds really simple.

Low volatility threat
Returns under plain vanilla bonds are safer compared to other exotic bonds. The simple reason being its essential features as well as liquidity. Such liquidity enables it to trade at tighter spreads which reduces the volatility risk of the company. Therefore, the danger of volatility is totally prevented in the plain vanilla bonds.

Greater liquidity
Envision an ice cream store, most buyers buy vanilla-flavoured ice creams and therefore, the maximum sales awareness would be from the sale of vanilla flavoured ice creams. Same phenomena use to plain vanilla bonds too. A large number of investors transact at higher frequency in plain vanilla bonds and therefore they have greater liquidity.

The primary disadvantage of a plain vanilla bond is that unlike any other financial product, these bonds cannot be adjusted in order to reflect the current marketplace conditions and prices established on the market. Therefore, once the prices become favourable to the investor, they wouldn’t be able to gain from the prices adjustment.