Before you start researching bonds to invest in, you need to be aware of different kinds of bonds available in the market. Depending on your investing goals, you can choose a category of bonds that will suit you most.
Corporate Bonds – These are bonds issued by companies that require large funds to finance expansion plans or to undertake other major projects. The corporate bond market is huge and far bigger than the government backed securities market. Different companies offer different interest payouts and maturity terms. Investors also have a high degree of control over their investments because they can choose company bonds within the industry they believe will flourish in the near future.
Corporate bonds need to be researched properly before you invest in them. The past and expected future performance of the company, the state of the industry, and the current economic situation – all these factors need to be considered before you put your hard-earned money in a corporate bond.
Government Bonds – The US Government has its own debt products. These debt securities are part of the bond market and are used to fund the government’s expenses. Bonds issued by the US government, also known as Treasury bonds or T-bonds, are one of the most risk free investment products in the world because they are backed by the government. As the government can make future payments through its tax revenue or by simply printing more money (in limited quantities), these bonds are also called ‘risk free securities’.
There are other government bond investments options too like Federal agency bonds. Government backed agencies like Fannie Mae and Freddie Mac issue debt to carry out their mortgage financing activities. The government backing to these agencies makes them about as risk free as direct government debt securities.
Municipal Bonds – Municipal bonds are usually offered by a city. Often referred to as Munis, they are popular because of the tax advantage they give to the investor. The interest paid on these bonds is exempt from federal income tax. Many of these bonds also come with state and local government tax exemptions. The risk with these bonds is quite low, through not as low as in government bonds, and the tax advantage makes them very attractive for investors in the high tax bracket.
However, the advantage comes at the price as the interest rate given by munis is usually lower than corporate bonds. You will need to calculate the net savings you make through the tax exemption to make sure that Munis is the right investment option for you.
Classification Based on Risk
In terms of risk involved, bonds can be classified as investment grade bonds or junk bonds. Investment grade bonds usually have a rating of BBB or higher and are seen as low risk investments. Junk bonds (or speculative bonds) are bonds which have a high risk of default, and are given a rating lower than BB by credit rating agencies.
Based on the manner of interest payment, bonds can fall in the category of zero coupon bonds. These do not pay a periodic interest on the investment amount. Instead, on maturity they pay an amount that is equal to the initial investment plus interest that has been compounded every half year.
The advantage with these bonds is that they are issued at prices that are substantially lower than their face value. The rate of interest is defined at the time of bond issue by the difference between the redeemable value on maturity and the actual amount you pay for the bond.
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