Posted in Finance, Accounting and Economics Terms, Total Reads: 506
Definition: Commodity-Backed Bond
It refers to a type of bond which derives its price from that of a commodity. Most of the bonds that are available in market for investment generally have a fixed price which is known at the time of the investment by the investors. But, that is not the case with commodity backed bond. Commodity backed bond can have price fluctuations based on the price movements of the underlying commodity that is tied with the bond.
The main aim of a commodity backed bond is not only for just investment in a commodity or a bond structure. It is mainly to hedge against various risks such as inflation and other investment risks. As the return in terms of hedging as well as investing is high for a commodity backed bond, the risk is also higher as compared to a normal bond. As the value of a commodity backed bond depends upon the underlying commodity, the price of which is not guaranteed and hence the cash flows of a commodity backed bond is also not guaranteed.
The returns can be higher in a commodity backed bond as compared to a traditional bond with increase in the price of the underlying commodity. The most common commodity underlying commodity backed bonds is gold. This is because gold is considered mainly as a source for hedging and any investor keeps a part of gold investment in its portfolio.