4 Main Different Types of Bonds to Choose From

People buy bonds with the purpose of earning interest from them. Bonds are usually issued by government, state or local government and corporate companies to get loan from public with predetermined interest.

4 Main Different Types of Bonds to Choose From

Government Bonds

Government bonds are issued by Treasury. There are mainly 3 categories of government bonds, differentiated by their respective maturity periods:

• Bills - where the maturity varies from 90 days to 1 year

• Notes - where the maturity is between 2 to 10 years

• Bonds - where the maturity is between 10 to 30 years

Government bonds are deemed to be the safest type of bonds because they are backed by the US government. Usually, Bonds pay the best interest compare to Bills and Notes as the maturity period is longer. As a buyer, your risk of holding a Bond is always higher than holding a Note or a Bill, but it is still the safest compare to other types of bonds, namely municipal bond and corporate bonds.

Municipal Bonds

They are also called the munis. This is another type of bond issued by the government. Generally, municipal bonds are issued by cities, local governments or their agencies. The risks of municipal bonds are a step above government bonds. A city would not bankrupt so easily although the possibilities are there. The main advantage of municipal bonds is they are triple tax-free. This is because under constitutional provisions, federal government is not allowed to tax on state or local bonds. Moreover, local governments usually exempt their residents from tax against their bonds.

Normally, the munis offer relatively lower yields due to their tax-free nature. However, it is a good investment as the net return may be higher than the regular bonds.

Corporate Bonds

Corporate bonds are issued by private companies to acquire loan from the public. They are the most risky among the many types of bonds. Hence, corporate bonds usually offer higher yields. The possibilities of defaults by corporate companies are always much higher than the government. Therefore, if you are buying a corporate bond, the stability of the company is the utmost important.

Generally, corporate bonds can be categorized by its maturity period:

• Short Term - refers to bonds which mature between 1 to 5 years

• Intermediate Term - refers to bonds which mature between 5 to 15 years

• Long Term - refers to bonds which mature after 15 years or more

There are various of ratings and yields in corporate bonds. For instance, if you are buying bonds from a blue chip company, they may be carrying an investment-grade rating such as AA (AA means a low yield but a lower default risk as well). If what you buy are from a low reputation company, the bonds may be carrying a "junk bond" rating (which means with a high yield but a higher default risk).

Zero-Coupon Bonds

They are sometimes known as the zeros. This is a type of bond which do not make periodic interest payment. Instead, it offers a great discount off its par value. Upon maturity, you are expected to get back the principle plus the compounded interest. People normally buy zero-coupon bonds as a plan for their retirement planning or child's education planning. The purpose is to withdraw the whole lump sum of money at a specific future date.

If you buy the zero-coupon bonds, one thing you need to take note of is though the interest is accrued and payable to you only upon maturity, but you are expected to pay the tax for the interest earned each year along the way.

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