A bunny bond is a coupon bond that gives the speculator the privilege to get coupon installments in cash or in additional bonds with the same coupon as the underlying bond. The purpose is to offer the investor protection from reinvestment risk (G. L. Gastineau, M. P. Kritzman, 1999, p. 47). This type of bond is also known as:
- a multiplier bond,
- a guaranteed coupon reinvestment bond.
In other words, a bunny bond is a bond or note structure that gives the holder a progression of alternatives to get each interest coupon in cash or to reinvest it in the same bond at par on the interest payment date. A holder choosing to reinvest all coupons thusly would make what could be compared to a zero-coupon bond. The intrigue of the guaranteed coupon reinvestment security is that it gives a holder adaptability to maintain a strategic distance from the reinvestment hazard related with having to reinvest coupons at lower rates than the first yield on the bond (G. L. Gastineau, M. P. Kritzman, 1999, p. 157).
"A zero-coupon bond is a bond, that pays a specified amount (called its face value or par value) at a specified time (called maturity). At times prior to maturity, the value of this asset is less than its face value, provided the interest rate is always greater than zero" (S. Shreve, 2005, p. 143). "A zero-coupon bond with principal £1 maturing in a year is precisely the same as receiving the sum of £1 in a year" (M. S. Joshi, 2003, p. 23).
Comparing Price Risk And Reinvestment Risk
The price risk identifies the current market value of the bond portfolio, while reinvestment risk relates to the income the portfolio produces. If you hold long-term bonds, you will face significant price risk because the value of your portfolio will decline if interest rates rise, but you will not confront much reinvestment risk because your income will be steady. On the other hand, if you hold short-term bonds, you will not be exposed to much price risk, but you will be exposed to significant reinvestment risk. A long-term zero coupon will have a significant level of price risk and relatively little reinvestment risk. In contrast, a short-term bond with a high coupon rate will have low price risk, but considerable reinvestment risk (E. F. Brigham, J. F. Houston, 2012, p. 237).
- Brigham E. F., Houston J. F. (2012), Fundamentals Of Financial Management, Cengage Learning, UK, p. 237
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Author: Elżbieta Woyke