Understanding The Cost of A Construction Performance Bond

performance bond - How are performance bond costs calculated - building

How are performance bond costs calculated?

The performance bond that you must post to secure an open position will be equal to 2 times the initial margin requirement. The initial margin is the amount of equity required by a market participant at order entry (entry price multiplied by a number of contracts).

For example, if the current price of EURUSD 1.3100 x 100 = 131,000; the Initial Margin Requirement would be 131,000/100 which equals $1310 per lot (rounding up). If you open 5 lots, then your Performance Bond would be (2 * 1310) + 4000 = 8,120 USD or 3150 GBP or 4175 EURO

What if the contract does not require 100% bond coverage?

Still other times, the contract provides for a certain amount of money to be deposited with the court clerk before litigation may commence; but does not explain what happens if litigation commences, and more than sufficient funds are made available to satisfy any judgment entered against the defendant, during or after the lawsuit.

Surprisingly often, people will assume that 100% of the face value of this bond must be paid to the plaintiff if he is successful. This assumption is incorrect in most cases.

The contract will usually provide that the surety, or insurer, agrees to “indemnify” or reimburse the defendant for money paid by him to satisfy a judgment, up to an aggregate sum of X dollars. Frequently this amount of money may be less than 100% of the face value of the bond. 

Is there a separate charge for performance and payment bonds?

A performance and payment bond is a single document. Many contractors use the terms “performance and payment” and “payment only” almost interchangeably because they are all part of what is called, “the bid package“. This [is] basically [all] the documentation that you need to obtain a contract from a general contractor or other governmental agency. 

Signing one document for both performance and payment protects your ability to finish the job on time while being paid at the same time. The advantage of this type of bond is that it can be used in multiple situations even if different requirements apply for each type of project. This guide explains how the two types work so you know which type of bond is right for your specific situation.

These types of bonds are not interchangeable and they serve two different purposes. The difference between the two is that a performance bond ensures you will complete the project and a payment bond ensures you will be paid to complete the project. In other words, a payment bond protects those who have been hired by a general contractor or another client from financial loss if you fail to perform as part of an agreement.

How much should a performance bond cost?

When considering a performance bond as part of your contracting cash flow it is important to be aware that the cost of such coverage will vary, depending on several factors. Pricing for this type of insurance is governed by industry standards and rates can vary significantly between providers. Prospective buyers should compare policies carefully before selecting a provider and consider additional costs such as premiums and fees when making their decision. Some of these factors include:

  • Type of Contract- The amount needed for your bond depends largely on what you’re bidding on and where you’re located.
  • Peril Covered- As with any insurance policy, the type of peril listed on your contract directly affects its cost. 
  • Type of Work- The type of work you’re bidding on can also alter your bond premium rate considerably.

Many factors go into determining the final price for contractor performance bonds including location, experience, bidding type, and specialization.

How do you calculate performance bond price?

The price of a performance bond is determined by the contract. The person requiring the performance bond specifies how it should be calculated, usually based on one or more of the credit events specified in the contract. These credit events include failure to deliver, non-payment or repudiation. 

One example would be that if two parties entered into an interest rate swap agreement and one party failed to pay when due, the other would buy protection from their counterparty for this type of credit event through an agreement specifying which calculation method should be used (if any) and what information will go into the calculation.

Performance bonds are routine in major derivatives transactions (such as commodity contracts), where they protect against a counterparty defaulting on its obligation. 

Performance bonds are not routine in other types of transactions, such as real estate deals or business contracts. If an obligor takes out a performance bond for a non-financial contract, it often uses the value of the underlying asset to determine the price. 

For example, if one company were buying another company, their lawyers would agree on what dollar amount constitutes adequate protection for each side against loss in the event of default by the other side before closing. The dollar amount set determines the price of a performance bond for this transaction.

Visit Alpha Surety Bonds to know more about performance bonds!

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