July 25, 2008

Bonds 101, part 3 - Treasury, Municipal, Corporate and Junk

In the first two articles I discussed the a basic overview of bonds and an explanation of bond terms. Now I'll take a closer look at the different types of bonds. The main categories of bonds are Treasury, municipal, corporate and junk.

Treasury bonds or 'treasuries' are issued by the U.S. federal government. As you may know the US government carries substantial debt and treasuries are one way they borrow money. Individuals can buy treasuries direct from the Treasury department. Treasuries are about the safest investment vehicle around and are backed by the full credit of the U.S. government. Due to the almost non existent level of risk in the investment treasuries have a relatively low interest rate.

Municipal bonds:
Municipal bonds or 'munis' are bonds issued by state or local governments. Local and state governments borrow money for a variety of projects: to build highways, fund schools, cover debts, etc. Munis are generally not taxable by federal or the state they are issued in. Municipal bonds have a very low default rate and so similar to treasuries they carry a relatively low interest rate.

Corporate bonds:
Bonds issued by corporations have a range of risk. Because the bonds are only backed by the credit worthiness of an individual corporation their risk is a bit higher and the interest rates are higher as well.

Junk bonds:
Corporate bonds with very high risk are known as 'junk' bonds. These are corporate bonds with the worst credit ratings and the highest risk levels for corporate issuers. Due to the high risk of default you can get pretty high returns on junk bonds.

What kind of bond should you consider investing in? It depends on your investment goals of course:

Very low risk - Treasury bonds are good for very safe investment.
Low risk and tax shelter - Muni's are good for a low risk investment with added tax benefits. If you have a high tax rate then munis can be especially attractive. If your tax rate is lower than munis are not as appealing.
Low risk and moderate return - Corporate bonds with high credit ratings can be a good moderate return investment with a low risk level.

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