A bond is a debt security, by which you are lending money to a government, municipality, corporation, federal agency or other entity known as the issuer. In return for the loan, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it becomes due.
Why Invest in Bonds?
It is always prudent for an investor to maintain a diversified investment portfolio consisting of bonds, stocks and cash in varying percentages, depending upon individual circumstances and objectives. Many people invest in bonds because they provide a predictable stream of income and repayment of principal.
Types of Bonds
Some of the more common types of bonds are:
Municipal bonds are issued by states, cities, counties and other governmental entities to raise money for financing public projects. Interest is generally paid semiannually. Issuers of municipal bonds have an outstanding record of meeting interest and principal payments in a timely manner.
Zero coupon Bonds
Zero coupon bonds are sold at a substantial discount from the face amount. When a zero coupon bond matures, the investor receives the full face amount of the bond. The difference between the amount that you actually pay to purchase the bond and the amount that is paid to you at the time of maturity represents interest.
U.S. Treasury Securities
U.S. Treasury securities-such as bills, notes and bonds-are debt obligations of the U.S. government. When you buy a Treasury security, you are lending money to the federal government for a specified period of time. They are considered to be the safest of all investments as interest and repayment of the principal amount is guaranteed by the federal government. Because of this unique degree of safety, interest rates are generally lower than for other widely traded debt, such as corporate bonds.
These are issued by private and public corporations. They are typically issued in multiples of $1,000 and/or $5,000. Interest is usually paid semiannually. Unlike stocks, bonds do not give you an ownership interest in the issuing corporation.
High-yield bonds are issued by organizations that do not qualify for “investment-grade” ratings by one of the leading credit rating agencies. The risk of default meaning not paying interest or principal in a timely manner is greater than other types of bonds. Issuers of such bonds must pay a higher interest rate to attract investors to buy their bonds and to compensate them for the risks associated with them.
Mortgage securities represent an ownership interest in mortgage loans made by financial institutions to finance the borrower’s purchase of a home or other real estate. Mortgage securities are created when these loans are packaged by issuers for sale to investors. As the mortgage loans are paid off by the homeowners, the investors receive payments of interest and principal.
Information is for educational and informational purposes only and is not be interpreted as financial advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.