Different Types of Bonds: What to Know Before Investing
Updated on 23 Mar 2020
Bond investments are known for being stable, secure investments. But there are many to choose from. Let us demystify the jargon for you!
Bonds are fixed-income securities or debt instruments. When you purchase a bond, you are giving out a loan to the bond’s issuer, who pays you interest for the use of your money. Bonds constitute a popular method of long-term investment, with a guarantee for maximum returns with minimum risks in the future.
Bonds are different from stocks –as they are sold by corporations, the government or its sponsored agencies, cities, states, and other public authorities. Bonds also come in several categories – from short-term notes to bonds that take 20 to 30 years to mature.
Let us go through the different types of bonds and what you need to know before investing your money in them.
What are the different types of bonds?
Bonds available in the market are:
1) Treasury Bonds
2) Other U.S. Government Bonds
3) Investment-Grade Corporate Bonds
4) Junk Bonds
5) Foreign Bonds
6) Municipal bonds
7) Mortgage-backed bonds
Almost all of these bonds in the U.S. fall into one of three categories, based on the risk factor involved.
- High Risk- These are rather high-risk bonds, sold by corporations, cities, and states. Those bonds are called Below-Investment-Grade, or Junk Bonds.
- Medium Risk- These are the low-risk bonds sold by corporations, cities, and states; these are known as “Investment Grade.”
- Low Risk- This category consists of the extremely safe debt of the federal government and its agencies. Ex. Treasury Bonds and US Government Bonds.
Let us now discuss these bonds one by one, so that you can have an idea as to which bond aligns with your investment situation along with the risks involved in the various bonds.
Treasury bonds are U.S. government debt securities. They have a maturity range between 10 and 30 years and a fixed interest rate. They pay semiannual interest payments until maturity, at which point the face value of the bond is paid to the owner. Such bonds are generally included in the portfolio to reduce portfolio risk.
The interest payments on these bonds are exempt from both state and federal taxation. The return on most T-bonds is tied to the 5-year Treasury rate. Young investors gain from Treasury Bonds, depending on their age at the time of buying them.
U.S. Government Bonds
These include the US Government Savings Bonds, and Agency bonds issued by federal agencies, like Fannie Mae or the Federal National Mortgage Association and Ginnie Mae from the Government National Mortgage Association. They promise a guaranteed fixed rate of return adjustment for inflation.
Series EE Savings Bonds are free from State and Local income taxes. Series EE savings bonds are capable of paying interest up to 30 years from the date of issue.
Investment-Grade Corporate Bonds
These are the High-grade Bonds that receive higher ratings by the credit rating agencies, like bonds rated BAA (by Moody’s) or BBB (by Standard & Poor and Fitch) or above.
These bonds tend to be issued at lower yields than other bonds. These bonds have a lower defaulting risk. They are from companies with higher repayment capabilities.
These are the bonds that have been given lower Credit ratings like “BB,” “B,” “CCC,” etc. by the credit rating agencies.
They come under the Low Credit Quality category. Companies with these ratings fall under the “speculative grade”. They are more prone to changing economic conditions.
A foreign bond is a bond issued in the domestic market by a foreign company or organization, as a means of raising capital. This bond is issued in the domestic market’s currency. Ex. Bulldog Bond in the UK, Samurai bond in Japan, and Kangaroo Bond in Australia.
Foreign bonds have higher yields than domestic bonds. They involve greater risks and face repayment risk. You can add foreign content to your investment portfolios with these bonds, without the added exchange rate exposure. The fixed interest payments and principal payments are in another currency.
The value of these payments when they are converted into dollars depends on the currency exchange rates.
These bonds are also known as “munis”. They are issued by the U.S. states and local governments or their agencies.
They come in both the investment-grade and high-yield bond varieties. They are generally used to finance public projects such as roads, schools, airports, etc.
The interest on these bonds is tax-free. Taxable yields are higher than muni yields to compensate investors for the taxes.
A mortgage bond is a bond secured by a mortgage or group of mortgages. These bonds are backed by real estate holdings.
In case of default, mortgage bondholders have a claim to the underlying property and could sell it off to compensate.
Mortgage bonds are safer than corporate bonds. They have a lower rate of return. Mortgage bonds offer investor protection because the principal is secured by a mortgage.
Investors can buy bonds in small quantities and use them to diversify their holdings. A diversified bond portfolio can provide decent yields with lower risk levels than equities. They also provide a higher income than money market funds or bank deposits.
The materials and data contained herein are for information only and shall in no event be construed as an offer to purchase or sell or the solicitation of an offer to purchase or sell any securities in any jurisdiction. Kristal Advisors does not make any representation, undertaking, warranty or guarantee as to the update, completeness, correctness, reliability or accuracy of the materials and data herein. All opinions, forecasts or estimation expressed herein are subject to change without prior notice. Kristal Advisors and its affiliates accept no liability or responsibility whatsoever for any direct or consequential loss and/or damages arising out of or in relation to any use of opinions, forecasts, materials and data contained herein or otherwise arising in connection therewith.