What Is An Investment Bond?
What is an Investment Bond?
In our unpredictable times, reducing the volatility of one’s investment portfolio should be the topmost priority of an individual investor. Continuing to add individual bonds to an investment portfolio is one of the best ways to minimize investment volatility.
The basic definition of a bond investment is that it is a debt obligation, issued by an issuer, usually in the person of the government or a corporation in need of additional capital. These governments and corporations issue bonds to raise capital for the creation of different governmental projects like bridges, hospitals or schools and/ or corporate factories. In essence, these entities borrow money from you, the individual bond investor. The bond will be repaid at face value by these debtor entities together with the fixed interest payments that the bonds earn.
The less likely the borrower is to default on payments to you, the less risky the bond; and the less risky the bond, the lower the interest rate the borrower is willing to pay. The riskiest of all bonds are the corporate bonds. In this case, the bonds holders will be given preference, in terms of paying the borrowed money, over the shareholders of the corporation.
The assets of a company, if it closes its business, are liquidated in the following order:
- Creditors
- Bond holders
- Preferred stock holders
- Common stock holders
Types of Bonds
The different kinds of bonds are:
Treasury bond – The issuer of this kind of bond is a government (ex. U.S. government). The issuer, in this case pay interest semiannually and are considered to be credit-free risk.
Agency bonds – Government-sponsored entities such as FHLM, FNMA, and GNMA issue this type of bond. These entities pay a slightly higher interest rate as compared to the treasury bonds for the reason that they are not fully secure to invest in and these bonds fluctuate more in value than other kinds of bonds.
Corporate bonds – Companies and/or corporations issue this type of bond for the purpose of paying the company’s projects and for capitalization. These bonds usually attract investors who seek higher rate of investment returns. This kind of bond entails a higher risk of default.
Municipal bonds – These are issued by state and local governments. They pay lower interest rates but are usually tax-exempt, so the after-tax return is attractive to many investors. The two main types are general obligation bonds and revenue bonds; general obligation bonds are safer that revenue bonds but often pay a lower interest rate.
Some bonds like municipal, government agency bonds and corporate bonds offer additional risk to your investment in that they can be redeemed by the issuer of the bond at full face value before the due date. An investor misses out on interest payments in this process.