Financial Bonds Explained

An unstable market has led to more popularity regarding the use of bonds as an investing tool. While markets are volatile, investments linked to bonds are much more stable. However, the stability associated with bonds often leads to a lower rate of interest earned on the investment. It's also important to note that not all bonds are created equal. Government Bonds These are the safest investments when it comes to bonds because they are backed by the United States Government. Bonds issued by the government are known as Treasury bonds because they are specifically issued by the Department of the Treasury. Treasury bonds can be purchased directly from the Department of the Treasury or through a bank. Currently, the longest term of a Treasury bond is 30 years. This means that the investor will have to wait 30 years until the bond can be cashed in. However, interest is paid to investors every six months. The interest rate on Treasury bonds fluctuates. The current yield on a 30 year Treasury bond is 3.32 percent, but this rate will change on a regular basis. Investors can consult financial publications and websites for up-to-date information conce ing Treasury bond yield. Treasury bonds are issued at a face value of $100. The actual selling price of a bond depends on how much an investor is willing to pay. No matter what an investor pays for a Treasury bond, the bond will only pay out $100 when it reaches maturity in 30 years. There are also short term Treasury bonds available. The yield on short term Treasury bonds tends to be much lower than the yield on 30 year bonds. For example, a three month Treasury bond currently yields an interest rate of .07 percent. Municipal Bonds Municipal bonds are a relatively safe investment because they are issued by local governments. These types of bonds are similar to Treasury bonds. The yield on a municipal bond varies greatly from city to city. It's also important to note that it is possible to lose an investment tied to municipal bonds. Although it is rare, cities have gone completely bankrupt in the past. An investor should research the stability of the local economy before deciding on investing in a municipal bond. There are tax benefits to investing in municipal bonds. The yield on the bonds is completely free of tax, and some cities allow residents of the city to cash in bonds with no tax consequences. Corporate Bonds Corporate bonds are where things start to get more risky. Issuing a bond is basically one way for a company to raise money to run the business. Corporate bonds are less risky than investing in the stock of a company. As long as the company stays in business and is able to meet its debt obligations, a bondholder will be entitled to cashing in the bond when it reaches maturity. If the corporation files bankruptcy, the bondholder will no longer receive interest or be able to cash in the bond at maturity. As with Treasury bonds, corporate bonds typically pay interest every six months. However, the interest earned on a corporate bond is taxable. High-yield Bonds These are essentially corporate bonds issued by a company that is on shaky ground and has a higher chance of filing bankruptcy in the future. Because the company is asking bondholders to take on a higher amount of risk, the possible rewards are much greater. The risk associated with high-yield bonds mean that they can sometimes pay up to 10 percent more interest than other corporate bonds. High-yield bonds are typically only a good idea for investors that can stand to lose the money spent on the bonds. Investing in bonds can be much safer than investing in the stock market, but there are still some risks involved. Investors need to understand how bonds work and should analyze whether they can stand to lose money before deciding which kind of bond is right for them.