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Definition: Commodity Backed Bonds
Commodity-backed bonds are defined as debt securities in which the bond value is related to the commodity price. It is bond wherein since the value is related to the commodity, repayment of principal amount or interests are linked to it.
These are an important source of financing for companies seeking long term funds and are mostly issued by companies that deal in or produce those commodities.
These are generally issued in two ways:
1. The rate of interest paid on the bond changes as the price of the commodity changes
2. The face value of the bond changes as the price of the commodity changes.
Because these are issued for a period of five years or greater they are shown in the long term liabilities section of the balance sheet.
Examples include rare metals like silver, gold, oil and coal. If the bond's interest rate is indexed to the commodity, then as the price of the commodity rises, the interest rate paid on the bond increases. This system offers a constant source of income for the investor and an opportunity to speculate.