In order to form an effective bond investing strategy one needs to understand the varying characteristics of the different kinds of bonds. The main types of bonds are categorized by what type of entity issues the bonds. The main types of bond issuing entities in the United States are the U.S. government, city governments and corporations.
Treasuries
Fixed-income securities issued by government are generally classified in accordance with the amount of time required to reach maturity. These categories of government securities are bills, notes and bonds.
Collectively, marketable securities issued by the U.S. government are known as Treasuries.
These treasuries are known as Treasury bills, Treasury notes and Treasury bonds. Treasury bills, also known as T-bills are technically not bonds due to the short maturity time of less than one year. Treasury notes mature in one to 10 years. Treasury bonds mature in more than 10 years.
Municipal Bonds
Municipal bonds are bonds issued by city governments. These bonds are commonly referred to as “munis”. Although municipal bonds are not as safe as Treasuries, they are still considered relatively safe since cities do not enter bankruptcy often, however it can possibly happen. Since the U.S. government issues its own currency, it cannot go bankrupt, which makes Treasuries significantly safer than municipal bonds.
Corporate Bonds
Just like government entities, corporations can also issue bonds. Usually a corporate bond of less than five years is considered short-term. Intermediate-term corporate bonds are five to 12 years. Long-term corporate bonds are more than 12 years. Usually corporate bonds are considered a higher risk compared to bonds issued by government entities. However, generally corporate bonds have higher yields.
Zero-Coupon Bonds
Zero-coupon bonds do not make coupon payments. Instead, these types of bonds are issued at a significant discount to par value. For instance, a zero-coupon bond with a par value of $1,000 with a 10-year maturity that trades at $600 would be purchased today for $600. However, in ten years the same bond will be worth $1,000.
These different types of bonds have their own advantages and disadvantages. How an investor utilizes these various bonds will depend upon one’s own risk profile. Each financial portfolio should be customized to fit each investor’s individual needs.
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Sources:
http://www.investopedia.com/university/bonds/bonds4.asp
