A bond is a loan agreement between the bondholder and a corporation or an agency of the government. The bond certificate reflects how much money has been lent by the bondholder and the date of repayment and carries with it the expectation that the amount will be repaid with interest. Bonds are a good source of passive income to incorporate into the financial portfolio.
Companies issuing bonds are rated by private entities like Standard & Poors or Moody’s. The company is provided with an investment “grade” dependent upon its performance and financial standing. The “A” rating is the best because it represents the lowest risk and the “C” rating is the worst because it represents the highest risk, often characterizing companies that are nearing bankruptcy. The higher the rating, the lower the interest rate the company will receive.
Just as there are different issuers, there are different types of bonds. The government issues bonds that mature in more than ten years and Treasury notes, also considered a type of bond, that mature in one to ten years. Government bonds are the least risky of all types of bonds available.
Municipal bonds have a slightly increased level of risk and are offered by local governments. One positive aspect of these bonds is that they are federal tax-free and some state governments also waive the tax requirement. Due to these reasons, the yield on a municipal bond is often lower than that of a bond that is taxable.
Corporate bonds are riskier due to chance of company default and come in short-term, intermediate, and long-term varieties. Short term is under five years, intermediate runs five to 12 years, and long term runs over 12 years. There are also callable bonds that can be redeemed by the company before they mature and convertible bonds that can be converted to stock by the investor. The last type of bond is a zero-coupon bond that has no coupon payments and is issued at a substantial discount to its par value.
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