Types of Bonds | Request More Information |
by Karen Murphy, MostChoice.com In order to distinguish one type of bond from another, you must first know who is selling you A bond will fall into one of four categories: those sold by the U.S. government and government agencies; those sold by corporations; those sold by state and local governments; and those sold by foreign governments. Each category varies by yield, risk and maturity, among other characteristics. And each category carries under it several types of bond options. In general, there are seven types of bonds: treasuries, government agencies, mortgage-backed securities, municipal bonds, zero coupon bonds, investment grade corporates and high yield bonds. TreasuriesTreasuries are secured by the US government and are therefore considered the safest type of securities. In addition to being easy to buy and sell, they also offer several maturities from less than a year to up to 30 years. The downside of Treasuries: low yields. Characteristics include:
The Treasury offers three types of securities:
Government Agencies or Government Sponsored Enterprises (GSE) Formerly called agencies, government sponsored enterprises (GSE) offer a higher yield than most Treasuries. Although very safe, they are not backed by the US to the same degree as Treasuries. They are issued by major federally sponsored agencies and the government is considered morally obligated to cover their obligation in case of a default. They are not quite as liquid and salable as Treasuries, thus the reason for their higher yield. Characteristics include:
Mortgage-Backed Securities Mortgage-backed securities are securities backed by a pool of mortgages, such as those issued by Ginnie Mae and Freddie Mac. Many mutual funds offer these big-ticket securities that are most popular among big institutions, such as insurance companies, pension plans and banks. However, their high yield, creditworthiness and diversity of available securities have made them increasingly popular among individual investors. They are considered a secure investment because issuers of mortgage securities are selective in choosing the mortgages which make up their pools. In addition, securities issued by Ginnie Mae, Fannie Mae and Freddie Mac carry added guarantees that affect timely payment of principal and interest and, in some cases, full repayment even if the mortgages in the pool default. Characteristics include:
Municipal Bonds Municipal bonds are debt securities issued by state and local governments, their agencies and enterprises with a public purpose. These groups include authorities for housing, toll roads and school districts, hospitals and universities. Considered a good investment for those in a higher income tax bracket, the interest income generated from a municipal bond is exempt from federal income taxes -- though the Alternative Minimum Tax (AMT) may apply. If the investor lives in the state and county that issued the bond, the interest income may also be exempt from state and local taxes, making the bond triple tax exempt. Characteristics include:
Zero Coupon Bonds Zero coupon bonds pay no periodic interest. Rather, the interest accrues and is paid in a lump sum at maturity when the bond is redeemed at its face value. Income from a zero-coupon bond comes from the bond appreciating in value over time. Its predictability makes the bond a valuable planning and investment tool. Most zeros are issued at a considerable discount from their face value. You can purchase government-backed zeroes, corporate zeroes as well as zero-coupon certificates of deposit (CDs). Characteristics include:
Investment Grade Corporates Investment grade corporates are are debt obligations issued by private and public corporations. Issuers represent various industry sectors including public utilities, transportation companies, industrial corporations, financial service companies and conglomerates. Companies use bonds to raise funds for a variety of purposes, from building facilities to purchasing equipment. The corporate bond market is large and liquid. Two markets buy and sell corporate bonds: the New York Stock Exchange (NYSE) and the over-the-counter (OTC) market. The OTC market is much bigger than the exchange market. Characteristics of investment grade corporates include:
High Yield Bonds High-yield bonds, also known as junk bonds, are corporate bonds issued by companies whose credit quality is below investment grade. Although they offer the possibility of higher returns, they also represent higher risks. Issuers of high-yield bonds vary greatly. They can be emerging companies that don't have the history, size or capital strength required to receive an investment-grade rating, or former investment-grade companies that are experiencing hard times. Other issuers may be companies that are refinancing debt; companies that need capital to fund acquisitions or buyouts, or to fend off hostile takeovers; or even foreign governments and foreign corporations that need to attract capital. Characteristics of high-yields include:
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