Baby bonds are bonds with a par value below $1,000. Additionally, the term also refers to savings bonds issued by the Treasury Department from 1935 to 1941. In the United Kingdom, the term refers to a tax-exempt savings program for children.
Baby bonds usually carry the same terms, coupon, and maturity as traditional bonds, although many are zero-coupon bonds. For example, let's assume XYZ Company wants to issue $5 million of bonds with a 6% coupon. XYZ Company may not see much interest from the capital markets for such a relatively small issue, because at $1,000 face value per bond, XYZ Company would only issue 5,000 bonds.
However, if XYZ Company issued $5 million of baby bonds with a $250 face value, it may actually generate more demand for the issue for two reasons. First, the bonds are more affordable to small investors. Second, the market for the bonds would be more liquid because there would be 20,000 bonds outstanding ($5,000,000 / $250) rather than 5,000 at the $1,000 face value. The bonds would still carry a 6% coupon, and XYZ Company's principal and interest payments would remain the same.
Although issuing baby bonds means managing and redeeming more bond certificates than would otherwise be the case with a traditional bond issue, baby bonds are often more affordable investments for small investors, and companies that cannot or do not need to do large debt offerings can use this tactic as a way to generate demand and a liquid market for their bonds.