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What Are The Types of Bonds Available For Investors?

Bonds are a type of debt security that is very similar to loans, only that they do not involve monthly payments and payment terms (i.e. installments, overdue charges). They are issued by an authorized entity, commonly the government, private finance companies, corporations, organizations and banks. Although they are not considered as loans per se, there are a lot of parallelisms between the two.

How Bonds Work

An issuer of a bond (borrower) signs them over to buyers who are now called bond holders (lenders). There will be a maturity period which can last from 5 to 15 years-sometimes more. During that period, as the issuer invests the money in other income-generating ventures, the holders are entitled to an annual payment of the coupon rate (interest rate) of the bond. On its maturity date, the issuer is obligated to repay the nominal amount (principal) invested by the holder.

There are four main types that are considered to be the most common:

Government Bonds - These are also called Treasury Bonds. These are released by the government, and are therefore considered as the "safest" or most "risk-free" type. The holders don't have to be worried about their funds becoming default because the government cannot rescind their duties on the bonds due to bankruptcy. This is the most common reason why issuers are no longer able to repay bond holders.

Municipal Bonds - This is a type of bond sold by the federal or local government. In the United States, these bonds are issued by the state government. These are usually released to provide funding for civic projects (ex. roads and infrastructure construction). The appeal of this type of bond for investors is that, as a public purpose funding, they are no longer subjected to income tax-or are at least granted reduced taxes.

Asset-Backed Bonds - This is a type of bond that can be issued by an individual as a form of debt repayment strategy. In essence, this bond is composed of smaller, illiquid assets that cannot otherwise be sold individually. It works in this manner: a borrower who has a number of unpaid loans can pool together all his remaining debts and transform it into a single bond security, which in turn can finally be sold off to investors. This debt-repayment strategy is also called as secularization, and is in fact not too different in concept from loan consolidation. Mortgage-Backed Bonds are examples of Asset-Backed Bonds (mortgages are pooled as the illiquid assets that makes up the bond).

Corporate Bonds - This is a type of bond that is issued by companies in an effort to earn investment capital that will be used for further income-generation (ex. expansion, construction of a new building or branch. The holders therefore serve as investors, each with a creditor stake on the company they bought bonds from.

There are still many more types of bonds that will come up in any conversation relating to this topic. Some of those often-used terms and types of bonds are Fixed Rate Bonds (interest remains constant during maturity), Zero-Coupon Bonds (no interest may be paid), Foreign Bonds (also called International Bonds) and War Bonds (issued by a country to finance the war efforts of another).

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