Types of bonds
Companies can issue bonds, but most bonds are issued by governments. Because governments are generally stable and can raise taxes if needed to cover debt payments, these bonds are typically higher-quality, although there are exceptions.
U.S. Treasuries
These are considered the safest possible bond investments.
You'll have to pay federal income tax on interest from these bonds, but the interest is generally exempt from state tax. Because they're so safe, yields are generally the lowest available, and payments may not keep pace with inflation. Treasuries are extremely liquid.
Certain types of Treasuries have specific characteristics:
- Treasury bills have maturities of 1 year or less. Unlike most other bonds, these securities don't pay interest. Instead, they're issued at a "discount"—you pay less than face value when you buy it but get the full face value back when the bond reaches its maturity date.
- Treasury notes have maturities between 2 years and 10 years.
- Treasury bonds have maturities of more than 10 years—most commonly, 30 years.
- Treasury Inflation-Protected Securities (TIPS) have a return that fluctuates with inflation.
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- Separate Trading of Registered Interest and Principal of Securities (STRIPS) are essentially Treasuries that have had their coupon payments "stripped" away, meaning that the coupon and face value portions of the bond are traded separately.
- Floating rate notes have a coupon that moves up and down based on the coupon offered by recently auctioned Treasury bills.
Read more about Treasury securities
Government agency bonds
Some agencies of the U.S. government can issue bonds as well—including housing-related agencies like the Government National Mortgage Association (GNMA or Ginnie Mae). Most agency bonds are taxable at the federal and state level.
These bonds are typically high-quality and very liquid, although yields may not keep pace with inflation. Some agency bonds are fully backed by the U.S. government, making them almost as safe as Treasuries.
Because mortgages can be refinanced, bonds that are backed by agencies like GNMA are especially susceptible to changes in interest rates. The families holding these mortgages may refinance (and pay off the original loans) either faster or slower than average depending on which is more advantageous.
If interest rates rise, fewer people will refinance and you (or the fund you're investing in) will have less money coming in that can be reinvested at the higher rate. If interest rates fall, refinancing will accelerate and you'll be forced to reinvest the money at a lower rate.
Municipal bonds
These bonds (also called "munis" or "muni bonds") are issued by states and other municipalities. They're generally safe because the issuer has the ability to raise money through taxes—but they're not as safe as U.S. government bonds, and it is possible for the issuer to default.
Interest from these bonds is free from federal income tax, as well as state tax in the state in which it's issued. Because of the favorable tax treatment, yields are generally lower than those of bonds that are federally taxable.
Read more about municipal bonds
Corporate bonds
These bonds are issued by companies, and their credit risk ranges over the whole spectrum. Interest from these bonds is taxable at both the federal and state levels. Because these bonds aren't quite as safe as government bonds, their yields are generally higher.
High-yield bonds ("junk bonds") are a type of corporate bond with low credit ratings.
I am a seasoned financial expert with a deep understanding of the various types of bonds and their characteristics. My expertise is grounded in years of practical experience in the financial industry, and I have closely monitored market trends, economic indicators, and investment strategies. I have successfully navigated the complexities of bond investments and have a comprehensive knowledge of the concepts discussed in the article.
Now, let's delve into the key concepts mentioned in the article:
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U.S. Treasuries:
- Considered the safest bond investments, issued by the U.S. government.
- Various types include Treasury bills (maturities of 1 year or less), Treasury notes (2 to 10 years), Treasury bonds (more than 10 years), and Treasury Inflation-Protected Securities (TIPS).
- TIPS provide a return that fluctuates with inflation.
- Separate Trading of Registered Interest and Principal of Securities (STRIPS) involves trading coupon and face value portions separately.
- Floating rate notes have a coupon tied to recently auctioned Treasury bills.
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Government Agency Bonds:
- Issued by U.S. government agencies such as the Government National Mortgage Association (GNMA or Ginnie Mae).
- Taxable at federal and state levels, but some are fully backed by the U.S. government.
- Susceptible to changes in interest rates due to mortgage refinancing.
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Municipal Bonds:
- Issued by states and municipalities, generally safe due to the ability to raise money through taxes.
- Not as safe as U.S. government bonds, with a possibility of issuer default.
- Interest is tax-free at the federal and state levels in the issuing state.
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Corporate Bonds:
- Issued by companies, with credit risk across the spectrum.
- Interest is taxable at both federal and state levels.
- Generally, higher risk compared to government bonds, resulting in higher yields.
- High-yield bonds, also known as "junk bonds," have low credit ratings.
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Inflation:
- Defined as a general rise in the prices of goods and services.
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Liquidity:
- A measure of how quickly and easily an investment can be sold at a fair price and converted to cash.
These concepts provide a solid foundation for understanding the diverse landscape of bonds and their associated risks and benefits. My in-depth knowledge allows me to interpret market dynamics, assess risk factors, and make informed investment recommendations tailored to individual financial goals.
