Let us define baby bonds.
Baby bonds are fixed-income securities in small denominations, usually from $25 to $500 face value instead of the $1000 of bonds. They attract regular investors like retailers who cannot afford to invest large denominations. The issuers of baby bonds can be anywhere from corporates, state governments to municipalities to generate project funds and capital expenditures.
Baby bonds are zero-coupon — they come discounted to their par value. Small companies are the ones who usually issue these to have more liquidity.
How baby bonds started
In 1935, Former US President Franklin D. Roosevelt created a baby bond program to promote saving among us citizens. Also, the savings allocation is for generating capital for long-term government programs. Later on, municipalities and corporations also started to issue baby bonds to raise long-term project funds. In the United Kingdom, baby bonds are tax-exempted.
After some time, Cory Booker, a presidential candidate running for the next US elections, created a baby bond proposal. This proposal aims to give every American baby born a $1,000 initial contribution and another $2,000 every year until the child reaches adulthood, depending on the family income. So if the children come from wealthy families, they will receive at least $1700, while children from low-income families will receive more — at least $4600 to be used on education and retirement needs.
Pros and cons for baby bonds
Let’s start with the advantages that baby bonds bring. First, they are liquid and efficient in trading since they are stock exchange-traded. They are offering higher returns and tax efficiency, unlike other bonds. People who choose baby bonds over other investments prefer company assets to equity shareholders when there is business liquidation.
On the other hand, with several advantages of baby bonds comes a lot of disadvantages. Listed below are some:
- Callable. Companies that issued baby bonds can collect them back even when it’s not yet the maturity date. The investor will receive lower yields and will lose interest rates.
- Hard to sell in economic downturns. Baby bonds are hard to sell due to the small denominations that give them limited liquidity in an economic downturn.
- No security. Baby bonds have high default risk with limited if no recovery collateral.
- High costs. Since baby bonds are small, the bond certificates are plenty, making the administration cost and redemption price higher.
- Issuers. The issuers don’t entice large institutions.
Baby bond example
Christian wants to invest his money, but he only wants to use $1,000. Instead of investing in a single bond worth $1,000, he chose baby bonds with small denominations of $50 from a retail company and $500 from the state since they generate higher returns even with less investment.
Baby bonds give mutual benefit to both investors and issuers. They attract small investors since they can be as cheap as $25 while helping small companies to generate funds for their projects. Any investment has its share of advantages and disadvantages, so an investor should always weigh what is best to support, whether investing with a big or small denomination.