Definition: Bonds are debt obligations issued by entities, such as local, state and federal governments or corporations. Bonds are issued to investors to raise money to finance the entity's operations or special projects.
When you purchase a bond, you are lending money to the entity, which in turn promises to pay you a specified amount of interest until the stated maturity date, at which time the original amount of the bond you purchased (the principal) is returned to you, the investor.
There are many different types of bonds but the primary issues include Treasury Securities, Municipal Bonds, Corporate Bonds and Junk (High Yield) Bonds:
US Treasury securities, also known as Treasuries, are debt obligations issued by the United States Department of the Treasury. When you buy Treasuries, you are financing the operation of the United States Federal Government. In different words, you are loaning money to the federal government. There are four types of Treasuries: 1) Treasury Bills (T-Bills), which mature in 1 year or less, 2) Treasury Notes (T-Notes), which mature in 2 to 10 years, 3) Treasury Bonds (T-Bonds), which mature in 20 to 30 years and 4) Treasury Inflation-Protected Securities (TIPS), which are inflation-indexed bonds.
Municipal bonds are bonds issued by government municipalities or their agencies. Examples include cities, states, and public utilities. The debt obligations are used to raise money to fund the building of schools, parks, highways, and other projects for public use.
Most municipal bonds and municipal bond funds offer income that is exempt from both federal and state taxes. Municipal bonds typically have low relative yields; the interest received by a bond investor is often lower in relation to other bond types, such as corporate bonds. However, the tax-free status of municipal bonds can create a tax-equivalent yield that is higher than other bond types.
Corporate bonds are debt obligations issued by corporations for the purpose of raising capital for corporate projects and other means of expanding the issuing corporation. For example, if Ford Motor Company wants to raise capital to build more manufacturing facilities, they can either issue shares of stock or issue bonds. If they issue bonds, investors and mutual funds can buy the bonds, which then become debt obligations of Ford Motor Company.
Basics on Junk (High Yield) Bonds
Also known as high yield, junk bonds are bonds that have credit quality ratings below investment grade (a rating below BBB by Standard &Poor's or below Baa by Moody's credit rating agencies. AAA is highest). A bond can receive a lower credit rating because of the risk of default on the part of the entity issuing the bond. Therefore, because of this higher relative risk, the entities issuing these bonds will pay higher interest rates to compensate the investors for taking the risk of buying the bonds, thus the name high yield.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.
