There are three broad categories of bonds:
- Government bonds
- Corporate bonds
- Municipal bonds
Government Bonds
Treasury securities are direct obligations of the U.S. government. A government security is one issued by the federal government or one of its agencies. Here are a few of the possibilities:
- Treasury bills – T-bills as they’re called are short-term government securities with maturity dates of no more than one year.
- Treasury notes mature between one and ten years from the issue date.
- Treasury bonds are long-term obligations of the federal government.
- TIPS (Treasury Inflation-Protected Securities) – If you’re worried about inflation eating away at the purchasing power of your investment, TIPS provide a layer of protection. The value of your security is adjusted based on changes in the Consumer Price Index. If inflation goes up, the value of your security goes up too.
With Treasury securities, the federal government guarantees the principal and interest. Even though your principal and interest is guaranteed, the value of your bond may be worth less or more than you invested if you need to sell it before the maturity date.
Corporate Bonds
Corporate bonds are issued because companies don’t always borrow from banks and often use bonds, instead, to raise money. The interest rate paid on a corporate bond depends on:
- The prevailing interest rate
- The credit-worthiness of the company
Just like individuals, some companies are a good credit risk and some are a bad credit risk. Here’s how it works:
- Bonds issued by financially-secure companies pay less interest than bonds issued by companies with existing or potential credit problems.
- Bonds issued by financially-troubled companies must pay a higher interest rate, because you are dealing with a corporation that is more likely to default on its obligations.
As an investor, you must decide if it’s worth taking more of a risk for a higher interest rate.
Municipal Bonds
A municipal bond is issued by a state, city, school district or public entity. Municipal bonds are usually exempt from federal income taxes. They may also escape state and local taxes. Municipal bonds pay less interest than taxable bonds of comparable quality. For example, a city that has financial problems must pay a high interest rate to attract investors, because it may default on its obligations to bond owners.
Bond Maturity
Along with choosing which type of bond to invest in, you must choose among varying maturity dates. Bonds are sometimes classified according to how long it takes for them to mature:
- Short-term bonds usually mature in three years or less. Because they mature relatively quickly, there is less risk that rising interest rates will hurt their value.
- Medium-term bonds normally have a maturity date of from three to seven years.
- Long-term bonds typically mature in seven years or longer.
Risks of Buying Bonds >> |
