Government Bonds
In general, f ixed income securities are classified according to the length of time before maturity. These are the three main categories:
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Bills - debt securities maturing in less than one year.
Notes - debt securities maturing in one to ten years.
Bonds - debt securities maturing in more than ten years.
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Marketable securities from the U.S. Government--known collectively as Treasuries--follow this guideline and are issued as Treasury bonds , Treasury notes , and Treasury bills (T-bills) . Technically speaking, T-bills aren't bonds because of their short maturity. All debt issued by Uncle Sam is regarded as extremely safe, as is the debt of any stable country. The debt of many developing countries, however, does carry substantial risk. Just like companies, countries can default on payments.
Municipal Bonds
Municipal bonds are the next progression in terms of risk. Cities don't go bankrupt that often, but it can happen. The major advantage to "munis" is that the returns are free from federal tax. Local governments also sometimes make its debt non-taxable for residents, making some municipal bonds completely tax free. Because of the tax savings the yield is usually lower than that of a taxable bond. Depending on your personal situation munis can be a great investment on an after-tax basis.
Corporate Bonds
A company can issue bonds just like it can issue stock. Large corporations have a lot of flexibility as to how much debt they can issue: the limit is whatever the market will bear. Generally a short-term corporate bond is less than five years; intermediate is five to twelve years, and long term is over twelve years.
Corporate bonds are characterized by higher yields because there is a higher risk of a company defaulting than a government. The upside is they can also be the most rewarding fixed-income investments because of the risk the investor must take on. The company's credit quality is very important: the higher the quality, the lower the interest rate the investor receives.
Other variations are convertible bonds , which the holder can convert into stock, and callable bonds , which allow the company to redeem an issue prior to maturity.
Zero Coupon Bonds
This is a type of bond that makes no coupon payments but instead is issued at a considerable discount to par value. For example, a zero coupon bond with a $1000 par value and ten years to maturity might be trading at $600. So today you pay $600 for a bond that will be worth $1000 in ten years.
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