Other Types of Bonds

 

What are Municipal Bonds?

Municipal bonds are a very popular way to earn tax-free income. They are a debt security issued by a state, municipality or county to finance its capital expenditures. The federal government cannot tax interest on state or local bonds and a local government will often exempt its own citizens from taxes on its bonds, so that many municipal bonds are safe from city, state and federal taxes. Depending upon investors’ tax rate, the net return may be higher than it would be on a regular bond.

What are Corporate Bonds?

Normally, corporate bonds yield more than Treasury securities. Corporate bonds can be the most attractive fixed-income investment as the investors are generally rewarded for the extra risk they take. The lower the company’s credit quality, the higher the interest investors are paid. However, it must be remembered that holding corporate bonds exposes investors to some of the same risks as holding the company’s stock.

Two of the most important risk factors associated with the corporate bonds are:

Call risk: If the corporate bond is callable, which means it can be redeemed the issuer prior to its maturity, then, the issuing company has the right to purchase or pay off the bond after some minimum time period.

Event risk: A corporate transaction, a natural disaster, or a regulatory change might cause an abrupt downgrade in a corporate bond.

What are Zero-Coupon Bonds?

Zero-coupon bonds have some unique features that make them effective tools for reaching certain financial goals. Like regular bonds, zero-coupon bonds are great for targeting a future financial need like retirement. Zero-coupon bonds are fixed-income securities and the bond is sold at a deep discount to its face value. This means that an investor might only need to come up with 70% or 80% of the face value of a 20-year or longer bond. And at maturity, the bondholder collects all of the compounded interest, plus the principal.

An example: Jane bought a bond with the face value of $20,000, maturing in 20 years, for $7,000. At the end of 20 years, Jane will receive $20,000. The difference between $20,000 and $7,000 represents the interest.

What are Bond Funds?

Bond funds are meant for those who want to diversify their investments with some fixed-income exposure. Managed by a professional investor who makes all the decisions and buys a portfolio of securities, there are bond funds for every preference. Most funds buy bonds of a specific type, maturity and risk profile and pay out a coupon to investors, often monthly, rather than annually or half-yearly like a regular bon prevailing interest rates. Before investing in bond funds investors should consider the risks of individual bonds and how they might affect a fund. The best strategy is to work with an investment consultant to determine one’s fixed-income needs, identify a fund that will help meet those needs, and evaluate the risks associated with it. d. However, the “fixed income” of a bond fund is not fixed. The dividend changes, depending on the bonds the fund manager has bought or sold, and the prevailing interest rates.

Before investing in bond funds investors should consider the risks of individual bonds and how they might affect a fund. The best strategy is to work with an investment consultant to determine one’s fixed-income needs, identify a fund that will help meet those needs, and evaluate the risks associated with it.