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Types of Bond Issuers – Which Type Of Bond Is Right For You?

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Introduction

 

 

 

When starting your bond investing education, it is important to understand the variety of bonds there are available to invest in. But it is also just as important to understand who exactly you are lending your hard-earned cash to. In this lesson, I am going to walk you through the 3 types of bond issuers, how they use your money to invest, the pros and cons to each bond issuer, along with ways to find out if a bond is worth the investment.

 

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

Types of Bond Issuers

 

The 3 main types of bond issuers are : The US government, Municipalities, and Corporations. Obviously, this can vary from country to country, since the legislative makeup if each country differs. Let’s start out with the US Government.

The US Government

 

 

The United States Department of Treasury issues 3 different types of bonds :

 

T–Bills : These have the shortest bond maturity and usually last a little over a year

T–Notes : Bonds that typically last between 1 – 10 yrs

T–Bonds : Bonds that expire within 10 years ( < 10 yrs.)

 

These bonds help fund the government’s day to day functions, such as the construction and development of public buildings, roads, or even provide funds to government sponsored agencies and operations such as the FBI, CIA, NSA, ect.

Interest and principal is returned from the taxes collected by the US government.

US Treasuries ( T-Bills, T-Notes, T-Bonds) is arguably one of the safest fixed income investments due primarily to the US government’s repayment track record – all because they have generated enough money via back taxes in order to pay back the bonds they owe.

Treasuries can potentially have tax benefits since the income a bond holder receives from coupon payment can be free from state and local taxes but can not be exempt from a federal level. To learn more you must consult with a tax attorney or tax specialist for more information.

 

 

Since treasuries are widely regarded as one of the safest investment assets with possible tax advantages, the bond yield as a result will be lower.

To read more about US Treasuries, check out my US Treasuries post :

Treasury And Agency Bonds – US Government Bonds

Municipalities

 

 

Municipal bonds or ‘muni’ is when the local or state government issues a bond. They rely on tax dollars and other revenue such as tolls or rent to repay the principal plus interest.

Muni bonds may be exempt from state and local taxes but they are considered to be tax-free from the federal government

Overall, municipal bonds are considered to be safe investments but there is always that slim possibility that a local/state government could default due to financial turmoil, but this is quite rare.

Selling a muni bond before expiration may require that you pay capital gain taxes

To read more about municipalities check out my municipal bonds post :

Investing In Municipal Bonds -The Tax Free Bond

Corporations

 

 

A corporate bond is a bond issued by a corporation or company. Corporations use bonds to further develop, expand, and reinvest the money in capital.

Corporate bonds are typically riskier since a company is more likely to go bankrupt rather than countries or municipalities.

The upside is of course is the higher bond yield with a greater coupon income to balance out the risk. Always make sure that they company is well-established and has a great track record of repaying their bonds.

If a corporation financial performance decreases, the bond price will decrease while the bond yield will increase

To read more about corporate bonds check out my corporate bonds post :

Investing In Corporate Bonds – The High Yielding Bond

Bond Risks

 

The risk that a bond carries is otherwise known a credit risk. Credit risk is the risk that a bond issuer will default on the bonds principal and interest payments – and this goes for all three types of bond issuers.

This is important to you, as the investor, if the credit risk associated with bonds is a good fit for your investment portfolio. Make sure that you take into account your personal preference with regard to your risk tolerance and time horizon.

A general rule of thumb (your take away) : A company that is a credit risk will see the price of their bonds fall – this may or may not be a bond that fit your needs, if your an aggressive or conservative investor.

 

 

If the worst case scenario were to occur……

Let’s say that you invested in a corporate bond and now the company has officially gone bankrupt. What happens next?

There is a pecking order in which any remaining money that the company has will be paid back to all investors alike, and is shown in following list.

  1. Secured Creditors will be paid first – these include banks who have invested in the company with collateral loans and bankruptcy expenses
  2. Unsecured Creditors are paid back next – which includes uncollateralized debt owed to banks, suppliers, employee wages, and bond holders
  3. Stockholders are the last to receive left over revenue – paying off preferred stock holders and then common stock holders

 

In order to reduce the odds of credit risk, find bonds where the issuers are less likely to default.

Rating Agencies help investors assess the degree of credit risk of various bond issuers

Prime examples of Rating Agencies includes the Standard and Poor (S&P), Fitch Ratings and Moody’s Credit Survey

Ratings help the issuers determine the coupon rate and yield – and in turn, help investors understand the risks that are associated with each bond.

I will explore bond rating agencies in more depth in a different post.

 

Quick Recap

In Review…….

The three types of bond issuers are :

The US Government

  • The United States Department of Treasury issues 3 different types of bonds :T–Bills : These have the shortest bond maturity and usually last a little over a yearT–Notes : Bonds that typically last between 1 – 10 yrsT–Bonds : Bonds that expire within 10 years ( < 10 yrs.)
  • These bonds help fund the government’s day to day functions
  • US Treasuries ( T-Bills, T-Notes, T-Bonds) is arguably one of the safest fixed income investments due primarily to the US government’s repayment track record – all because they have generated enough money via back taxes in order to pay back the bonds they owe
  • Treasuries can potentially have tax benefits since the income a bond holder receives from coupon payment can be free from state and local taxes but can not be exempt from a federal level. To learn more you must consult with a tax attorney or tax specialist for more information
  • Since treasuries are widely regarded as one of the safest investment assets with possible tax advantages, the bond yield as a result will be lower

 

Municipalities

  • Municipal bonds or ‘muni’ is when the local or state government issues a bond. They rely on tax dollars and other revenue such as tolls or rent to repay the principal plus interest
  • Muni bonds may be exempt from state and local taxes but they are considered to be tax-free from the federal government
  • Overall, municipal bonds are considered to be safe investments but there is always that slim possibility that a local/state government could default due to financial turmoil, but this is quite rare
  • Selling a muni bond before expiration may require that you pay capital gain taxes

 

Corporations

  • A corporate bond is a bond issued by a corporation or company. Corporations use bonds to further develop, expand, and reinvest the money in capital
  • Corporate bonds are typically riskier since a company is more likely to go bankrupt rather than countries or municipalities
  • The upside is of course is the higher bond yield with a greater coupon income to balance out the risk. Always make sure that they company is well-established and has a great track record of repaying their bonds
  • If a corporation financial performance decreases, the bond price will decrease while the bond yield will increase

 

Bond Risks

  • The risk that a bond carries is otherwise known a credit risk. Credit risk is the risk that a bond issuer will default on the bonds principal and interest payments – and this goes for all three types of bond issuers
  • This is important to you, as the investor, if the credit risk associated with bonds is a good fit for your investment portfolio. Make sure that you take into account your personal preference with regard to your risk tolerance and time horizon
  • A general rule of thumb (your take away) : A company that is a credit risk will see the price of their bonds fall – this may or may not be a bond that fit your needs, if your an aggressive or conservative investor

 

When A Bond Issuer Defaults, Investors Are Paid Back In The Order That Follows…….

  1. Secured Creditors will be paid first – these include banks who have invested in the company with collateral loans and bankruptcy expenses
  2. Unsecured Creditors are paid back next – which includes uncollateralized debt owed to banks, suppliers, employee wages, and bond holders
  3. Stockholders are the last to receive left over revenue – paying off preferred stock holders and then common stock holders

 

And those are the different types of bond issuers – along with the different aspects and benefits of each. I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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