Bonds are a popular investment choice due to their ability to provide regular income, preserve capital, and offer diversification benefits. Essentially, a bond represents a loan agreement between a borrower and a lender. When an individual or entity purchases a bond, they are lending money to the issuer for a specified duration. The issuer, in turn, commits to repaying the principal amount at the end of the term, along with an agreed-upon interest rate.
Different Types of Bonds
The various types of bonds include:
Corporate bonds: Corporate bonds are fixed-income securities issued by corporations to raise funds for their operations or expansion projects. Investors, whether private or institutional, purchase these bonds, effectively lending money to the company. In return, the company agrees to make regular interest payments (known as the bond coupon) and repay the principal amount at the bond's maturity.
Treasury bonds: Treasury bonds are long-term investments issued by the U.S. government, typically maturing in 10, 20, or 30 years. Known for their safety, these bonds are backed by the full faith and credit of the U.S. government, making them one of the most secure investment options available. Due to their low risk, Treasury bonds generally offer lower yields compared to other types of bonds. Investors often use Treasury bonds as a reliable long-term investment strategy.
International Government bonds: These bonds are debt securities issued by foreign governments and they offer higher yields and a great opportunity for investors to diversify their portfolio across various countries or regions.
Municipal bonds - These bonds are debt securities issued by states, cities to fund various development projects or operations. These bonds are exempted from tax since the interest earned is frequently exempt from FDIC and available for both short term and long term.
Agency bonds: Agency bonds are debt securities issued by government-sponsored enterprises (GSEs) or federal agencies. While not directly backed by the U.S. government, they enjoy a strong reputation for safety due to their close ties to the government. These bonds help finance public projects and typically offer higher interest rates than Treasury bonds.
High-yield bonds: High-yield bonds are corporate bonds issued by companies with lower credit ratings and offer higher yields (interest rates). Startup companies or capital-intensive firms issue high-yield bonds and promise to pay the interest regularly and return the principal amount on maturity of bonds.
Features of Bonds
Here are the key features of bonds:
- Face Value (Par Value): This is the amount paid back to the bondholder at maturity.
- Coupon Rate: The interest rate the bond issuer will pay on the face value of the bond, expressed as a percentage. For example, a 5% coupon rate on a $1,000 bond means the bondholder will receive $50 annually.
- Coupon Dates: The dates on which the bond issuer pays interest to the bondholder. This could be annually, semi-annually, quarterly, or monthly.
- Maturity Date: The date on which the bond will mature, and the bond issuer will pay the bondholder the face value of the bond.
- Issuer: The entity that issues the bond, which could be a corporation, government, or other organization.
- Yield: The return an investor realizes on a bond. There are various types of yield, including current yield and yield to maturity.
Bottom line
Bonds are a versatile investment tool with various types to suit different investor profiles. From government-backed Treasury bonds to corporate bonds with varying risk levels, the bond market offers a range of options for building a well-diversified portfolio. You can also consider Compound real estate bonds which offer 8.5% APY with no lock-in period.
