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What types of Bonds exist?

If you are planning for retirement or need to have some cash liquid, you might want to consider buying bonds. There exists a very large number of bonds on the market which can be purchased. The manner which returns are paid out to bondholders varies significantly. The most commonly traded bonds include:

Regular Bond Category

  • Inflation-indexed bonds: These are bonds whose payments are indexed to keep up with inflation. Owners of these bonds are protected from sharp increases in the cost of living.
  • Secured bonds (covered): These bonds are backed by underlying assets such as property (mortgage backed securities) and collateralized debt obligations.
  • Government bonds: These are bonds issued by national governments to fund government spending such as infrastructure projects. US Treasury bonds are considered the ‘safest’ investments as their value is backed by the full faith and credit of the United States government.
  • Municipal bonds: These are issued by states, territories or local governments for the same purpose as government bonds. Some of municipal bonds may be tax exempt.
  • Fixed Rate bonds: These are ‘standard’ bonds which have constant coupon payments throughout their lifetimes. They are however exposed to interest rate risk and should interest rates increase the value of the bond decreases. Conversely, should interest rates decrease, bond values will increase accordingly.

Common Bond Variations

  • Zero Coupon bonds: These are bonds which are issued at a discount to their face value (value at maturity) and the owner receives a premium of the purchase price at maturity. As opposed to regular bonds, there are no regular interest payments and the only gain is the capital gain. This is generally beneficial for the owner as taxes on capital gains are substantially lower than taxes on regular income.
  • High yield bonds: These are otherwise known as ‘junk bonds’. Bonds which are rated ‘junk’ have debt which is considered high risk and have a greater probability of default. These bonds are rated below investment grade by credit organisations such as Moody’s/ Fitch and are not considered appropriate investments for individuals who have a low tolerance for risk. To compensate for their risk profile, these bonds offer significantly higher yields.
  • Convertible bonds: These allow bondholders to exchange their bonds for a number of shares of common stock. These bonds combine debt and equity.

Conclusion

There are major variations between the different types of bonds which corporations can issue. Understanding the discrepancies between these bonds can help you as an investor to make to most informed decision possible and pick the investment bond that suits you best and helps you plan for your future.

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Motley Fool contributor mpinto has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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