What are Bearer Bonds?
Bearer bonds are debt instruments issued by governments and corporations that are not registered to any owner. They’re unregistered as investment securities and completely anonymous. As a result, no records exist that list the owners’ names. They are outlawed in the USA due to their use in illegal activities like money laundering and tax evasion.
They differ from traditional bonds in that they’re unregistered as investment securities. As a result, whoever physically holds the paper on which the bond is issued is the presumed owner. It gives them a greater measure of anonymity than more common bond offerings present. But, since no investor names physically appear on bearer bond papers, it’s nearly impossible to recover such bonds if they’re lost or destroyed.
Both bond types state maturity dates and interest rates. However, bearer bonds have coupons for interest payments physically attached to the security. They must be clipped or removed and then submitted to an authorized agent in order to receive payment. Bearer bonds aren’t issued in the U.S., having essentially been outlawed in 1982. Nevertheless, some are still in circulation. If you inherit one, you can collect the value, and in some cases interest. Besides buying or inheriting bearer bonds, you can still get them in the foreign countries that allow them to be issued.
Bearer Bonds – A Closer Look
Bearer debt instruments became popular in the U.S. after the Civil War. Clearly, they were easier to transfer than the equivalent amounts of cash. But, this is exactly why they were phased out in the 1980s. They are anonymous and can easily be used illegally for money laundering and tax evasion. In some countries, banks still issue bearer bonds, sometimes called coupon bonds, to holders in exchange for an investment. Holders can clip or remove coupons attached to the certificates and present them to the bank to collect interest. They are transferable, have little documentation, and can be redeemed at the bank by anyone bearing the certificate. They are still available in many countries.
In the U.S., bearer bonds were issued by the U.S. government and by corporations from the late 19th century into the second half of the 20th century. They fell out of favor gradually as legitimate investors became concerned about vulnerability to loss or theft. They were finally outlawed by the government to combat money laundering and tax evasion.
Modern Bonds
Nearly all securities are now issued in book-entry form. This means they are registered in the investor’s name electronically. Often, no physical certificate is even issued. A registrar or transfer agent is responsible for tracking the name of each registered owner of a stock or a bond. This ensures that bond owners receive all interest payments due and that stockholders receive their cash or stock dividends. Every time book-entry securities are sold, a transfer agent or registrar changes the name of the registered owner.
Bearer Bonds and U.S. Restrictions
The Tax Equity and Fiscal Responsibility Act of 1982 effectively ended the practice of issuing bearer bonds in the United States. Bearer bonds are no longer issued by the U.S. Treasury. Those issued in the past have long since passed their maturity dates. In 2009, the multinational financial services company UBS paid $780 million in fines and penalties. They subsequently agreed to a deferred prosecution agreement with the U.S. Justice Department. This was after the bank was accused of helping American citizens evade taxes using bearer bonds.
Advantages of Bearer Bonds
Clearly, the advantage to bearer instruments is anonymity. Bearer bonds have no registered owner so there’s no record of who purchases the bonds. Also, they are not tracked if or when they are sold and who collects interest payments. The advantages of bearer bonds include:
- Revenue – They are a source of raising finance by companies and governments. The funds can then be used to finance the growth and development of the economy.
- Bear interest – The annual or periodical interest payment is acknowledged and paid immediately once the coupon for interest payment is presented.
- Transferable – They are easily transferable from one individual to another without much hassle.
- Redeemable – They are easily redeemable at interest maturity dates.
- Anonymous – The anonymity of the owner can be kept and maintained with bearer bond investments.
Risks of Bearer Bonds
Owning bearer bonds can carry risks because of their similarities to cash. If lost, stolen, or damaged, there is no way to replace them. Most of the anonymity that bearer bonds once offered is now gone. Even though the holder can still redeem the bond, US citizens must register their Social Security number and pay taxes when doing so. Multiple risks are attached with the bearer bonds:
- Money laundering – The risk of money laundering is high. Investors might use this for the purpose of transferring illegal funds and reinsert it into the economy through a legitimate source.
- Tax evasion – The risk of tax evasion also exists as the investor can remove this money from their financial accounts. Then, invest and earn interest without declaring the income.
- Illegal activities – They lead to the circumvention of law and concealment of business transactions.
- Theft – Tracing or determination of the rightful owner is not possible in case of theft.
- Loss – The risk of loss of value arises in case the bond papers are destroyed or lost.
Do Bearer Bonds Still Exist
For most U.S. citizens, buying bearer bonds is impractical. Issuers in other countries still use bearer bonds, and you can buy them. But, for US citizens, it is illegal to use them anonymously. The IRS and other agencies require that you inform the U.S. government about your holdings. There are significant risks to buying these securities. This includes the risk of default and the risk of theft. Instruments that facilitate money laundering and tax evasion may come with added suspicion and scrutiny. Also, modern bearer bonds typically carry less favorable terms than registered debt instruments. All bearer bonds issued by the U.S. Treasury have matured.
Example
For example, an investor purchases bearer debt instruments for $5000 value from the Bank of Luxembourg. The coupon rate is 8%. The Bank pays a fixed interest of $400 ($5000 x 8%) to investors. To collect interest, an investor has to tear or clip the coupon from the bond papers and present it to the agent of the bank. Anyone else on behalf of the investor can also collect the coupon payment. In case of theft, the bank will not ask any questions. They will pay the bearer the specified interest or redemption amount.
Up Next: What Is Buying on Margin?
Buying on margin means borrowing money from your brokerage company and using that money to buy stocks. It is no different than taking out a loan to buy stocks. If the stock price goes up, you can repay the loan with the gain. If the stock price goes down, you will have to repay the loan with additional cash to top up your trading account.
In other words, you’re simply taking out a loan, buying stocks with the lent money, and eventually repaying that loan at a later date. Also, there is interest to consider on the borrowed funds.
