Types of Bonds

By Kevin Chambers

For information on the basic principal of bonds, check out the previously posted Understanding Bonds.  Now let’s review the different types of fixed income investments in a typical portfolio managed by Headwater Investments. As a reminder, Headwater Investments rarely buys individual bonds.  Instead, we usually buy mutual funds that contain hundreds or thousands of individual bonds. Some of the mutual funds invest in one type of bond, while others invest in various types of bonds. 

Government Bonds:

These are bonds that are issued by the U.S. government. They are also referred to as Treasuries. Bonds that are issued by the U.S. government are considered very safe as it is very unlikely that the federal government would default on their debt.

U.S. government bonds are broken into three sub-categories: Treasury Bills, Treasury Notes, and Treasury Bonds. T-bills have maturities of less than one year; T-notes have maturities of up to 10 years; and T-bonds have maturities of more than 10 years. Because of their varying maturities, the different types of bonds have different interest rates. Typically, the longer the maturity, the higher the interest rate. The interest rates change daily. The current rates are posted daily on the Treasury Department’s website. 

Municipal Bonds:

Municipal bonds, or muni bonds for short, are issued by cities, states, counties, and other local government entities to fund capital expenditures. These bonds are considered riskier than U.S. government bonds because it is more likely that a small local institution would not be able to make all of the bond payments versus the federal government. Muni bonds are given a rating by a rating agency, such as S&P or Moody’s, based on the amount risk or possibility of default by the bond issuer. The main advantage of muni bonds is that the returns are exempt from federal taxes. This makes them a popular investment for those investors in higher tax brackets.  

Corporate Bonds:

Corporations can also issue bonds. Corporate bonds are considered higher risk bonds and are given a rating from a rating agency. Because of the higher risk of default associated with corporate debt, investors are usually given a higher yield. Depending on the company and the maturity of the bond, investors will receive higher or lower yields. For example, General Electric bonds are going to be safer and give investors a lower yield than a start-up technology company.  Short-term corporate bonds are less than 5 years; intermediate term corporate bonds are up to 12 years; and long-term bonds are over 12 years in maturity.  Corporations also issue very short term debt instruments called commercial paper that have maturities less than 270 days.

Money Market:

Money market securities are very short-term debt securities from various issuers. These are extremely liquid, conservative, safe investments that are often thought of as analogous to cash. In a money market fund, you will find T-bills, commercial paper, bank CDs, and other short-term instruments. Because these investments are short term and very safe, they give investors very low return. Currently, money market investments are offering essentially 0% yields.