In building your portfolio, bond investment plays the same essential role as stock and real estate investment. Here is the basic overview of how it works and also the types of bonds.
The Definition
Bond, in its most basic definition, is a type of loan. The loan is temporary and it is from the investors’ capital. In exchange, those investors get interest income at a predetermined date (the maturity date) and rate (the coupon rate).
If it happens that the investors do not receive the interest paid up to the maturity date, then the bond can be said is in default. Once the default happens, then investors have to rely on the legal contract governing their bond issue.
This legal contract is also commonly known as bond indenture. However, unlike the 10-K, annual report, or a share of stocks, this document is a little bit harder to obtain. Yet, the broker should always have the ability to help you track down the necessary filings of bonds that catch investors’ attention.
Types of Bonds
One specifics bond can vary wildly, but here are the types that have come up over the years.
Sovereign Government Bonds
Sovereign government issues this type of bond. Investing in this type of bond means the investors rely so much on the credit of the country, including the power to tax to meet its constitutionally required obligations.
The sovereign government usually also issues other special types of bonds other than their primary obligations. As an example, sometimes government agencies also issue agency bonds to fulfill the specific mandates.
Municipal Bonds
State and local governments issue this type of bond. Usually, municipal bonds are tax-free in order to achieve two things. The first, municipality can enjoy a lower interest rate than the taxable bonds. That way, it is easier for them to free up some amount of money every time there is an important cause.
The second, it encourages investors to invest in various civil projects. In the long run, it improves civilization like funding bridges, roads, hospitals, and many more.
Corporate Bonds
These bonds are issued by corporations, limited liability companies, partnerships, and other commercial enterprises. These bonds usually offer a higher yield than the other types of bonds.
Yet, these bonds have higher tax rates than other bonds. As an extreme case, an investor may end up paying 40% to 50% of the total investment income to the local government or state. Thus, these bonds are less attractive unless the investors can utilize some loophole or exemption.
