Different Types Of Bonds

Different Types Of Bonds

There are many different types of bonds available in the market. The ideal choice for an investor will depend largely on their investment objectives. Riskier bonds tend to be ideal for investors who seek higher returns and don’t mind taking on more risk. However, investors who are more conservative and are saving for a future event are better off with less risky bonds such as government bonds and high rated corporate bonds.

Municipal Bonds

Municipal bonds are sometimes referred to as Munis. Much like federal government bonds, they are considered to be safe assets because it is rare for a municipality to declare bankruptcy. In the United Sates, municipal bonds are a popular investment choice because the interest earnings are exempt from federal income tax. In some cases, the municipality will also charge low taxes to residents of the municipality who hold the bonds. In addition, some municipalities also exempt the local investor from paying taxes on the earnings all together.

Investors who lend money to municipal governments also have the indirect advantage of funding different public projects such as public transit or infrastructure.

Corporate Bonds

Corporate bonds are not considered as safe as government bonds because it is more common for companies to go bankrupt than government bodies. For this reason, corporate bonds compensate investors for the increased risk by offering a higher return than government bonds. A corporate bond that matures in five years or less is usually considered to be a short term bond, whereas a long term bond usually matures in twelve years or longer.

Corporations also offer investors more options when investing in bonds. In some cases, they may issue convertible bonds, which can be converted into the company’s common stock.

Chart showing bond growth.

Zero Coupon Bonds

This type of bond does not make periodic coupon payments until the bond matures. Instead, they are usually sold at a discount. This means that an investor can purchase a bond worth one hundred dollars for significantly less. For example, if the bond is worth one thousand dollars, you can purchase it for as low as seven hundred dollars.  When the bond reaches maturity, the investor earns the actual value of the bond, and not the amount that he or she paid. Since zero coupon bonds pay one lump sum at maturity, they tend to vary in price much more than traditional bonds.

Government Bonds

Government bonds can be issued as traditional bonds, notes or bills. Bonds differ from notes because government bonds mature in more than ten years whereas notes can mature anywhere between one and ten years. Finally, bills are basically short term loans that are made to the government and they typically mature in less than one year. Government bonds are the safest assets available in the market. However, for this reason they also earn a relatively low return. It is important to note that not all government bonds are risk free. Although government bonds from developed countries are considered safe, those that come from developing nations are usually considered riskier assets.

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