What Is a Bond?

Generally speaking, a bond is a type of loan that public and private entities receive by selling IOUs, or bonds, to cover their various expenses. 

You can find bonds advertised for sale to the general public in the business/finance section of major newspapers, in financial publications, through the investment company you use and on the Internet via various investor websites – e.g., Scottrade, FMS Bonds Inc., TD Ameritrade, the U.S. Treasury.

There are many types of bonds with varying levels of risk and rates of return, or yield:

• Governments Bonds– government issued bonds; regarded as extremely safe; 6.99% average yield; fixed interest rate.
• Municipal Bonds – issued by municipalities; regarded as relatively low risk, since municipalities don’t typically go bankrupt; no federal taxation, some are tax free from municipal taxes; lower in yield than taxed bonds; 1 to 5% yield based on length of term to maturity; interest could be could be fixed or variable.

Video: What is a Bond?

• Corporate Bonds – issued like stock; higher yields due to higher risk; the higher the company’s credit quality, the lower the yield for the investor; variable yield in excess of 5%.
• Zero Coupon Bonds – operate very similar to a savings bond; purchased at a discounted price, but is worth a significantly increased amount at maturity; yield at maturity.

In regards to risk, many bonds are rated by ratings agencies like Standard and Poor’s, Moody’s Investors Services and Fitch Ratings.  Thinking about investing in a bond other than one backed by the government?  You’ll want to do some research on the originator to make sure the risk is minimal.

What Are Government Bonds?

A government entity initiates a government bond to obtain monies to pay for specific debt obligations for completing certain projects for the public good.  The bond provides the government entity financing for the certain projects.  All government bonds are considered fixed income debt securities, and are categorized according to their duration before maturity.  Fixed rate means that the interest rate won’t fluctuate based on the prime rate.  Government bonds are separated into several categories – “T” for Treasury: 

• T-Bonds – Treasury bonds mature in more than 10 years.
• T-Notes – Treasury notes mature in 1 to 10 years.
• T-Bills – Treasury bills mature in less than 1 year.
• Ginnie Mae Bonds – Government National Mortgage Association (GMNA) bonds typically mature when the mortgage is paid off; however, investors are paid monthly dividends.

Some other government bond facts are as follows:

• Government entities sell bonds to registered securities – e.g., banks, securities companies, typically in lots of $1M.
• Registered securities sell the bonds to the general public at a specific interest rate, which is paid out semi-annually.
• Government bonds mature over a specific period of time, usually 1 to 30 years.
• Not all yield generated from government bonds is exempt from federal and state taxes.

Video: Bond, James Bond (Jerry Lewis Parody)