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Why do people buy bonds?
Investors buy bonds because:
- They provide a predictable income stream. Typically, bonds pay interest twice a year.
- If the bonds are held to maturity, bondholders get back the entire principal, so bonds are a way to preserve capital while investing.
- Bonds can help offset exposure to more volatile stock holdings.
Companies, governments and municipalities issue bonds to get money for various things, which may include:
- Providing operating cash flow
- Financing debt
- Funding capital investments in schools, highways, hospitals, and other projects
What types of bonds are there?
There are three main types of bonds:
- Corporate bonds are debt securities issued by private and public corporations.
- Investment-grade. These bonds have a higher credit rating, implying less credit risk, than high-yield corporate bonds.
- High-yield. These bonds have a lower credit rating, implying higher credit risk, than investment-grade bonds and, therefore, offer higher interest rates in return for the increased risk.
- Municipal bonds, called “munis,” are debt securities issued by states, cities, counties and other government entities. Types of “munis” include:
- General obligation bonds. These bonds are not secured by any assets; instead, they are backed by the “full faith and credit” of the issuer, which has the power to tax residents to pay bondholders.
- Revenue bonds. Instead of taxes, these bonds are backed by revenues from a specific project or source, such as highway tolls or lease fees. Some revenue bonds are “non-recourse,” meaning that if the revenue stream dries up, the bondholders do not have a claim on the underlying revenue source.
- Conduit bonds. Governments sometimes issue municipal bonds on behalf of private entities such as non-profit colleges or hospitals. These “conduit” borrowers typically agree to repay the issuer, who pays the interest and principal on the bonds. If the conduit borrower fails to make a payment, the issuer usually is not required to pay the bondholders.
- U.S. Treasuries are issued by the U.S. Department of the Treasury on behalf of the federal government. They carry the full faith and credit of the U.S. government, making them a safe and popular investment. Types of U.S. Treasury debt include:
- Treasury Bills. Short-term securities maturing in a few days to 52 weeks
- Notes. Longer-term securities maturing within ten years
- Bonds. Long-term securities that typically mature in 30 years and pay interest every six months
- TIPS. Treasury Inflation-Protected Securities are notes and bonds whose principal is adjusted based on changes in the Consumer Price Index. TIPS pay interest every six months and are issued with maturities of five, ten, and 30 years.
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