Investment Grade Bonds for Investors with a Different Risk Profile
A bond is a form of debt security that is issued by a corporation or government. Holders earn interest while the principal is repaid at maturity. They receive interest at regular intervals that can be monthly, annual, or semiannual.
Types of Bonds
There are different types of debt securities, including government notes and bills, zero coupon, corporate, municipal, and others. Corporate bonds are issued by companies and have different terms. Some have a term of over 12 years while others – up to 5 years. The main benefit for holders is that they enjoy higher yields, but the risk of default is also higher. This is why, it is important to check the creditworthiness of the company. Businesses with a high credit quality offer low interest rates while those with poor credit are the ones to offer high yields. In addition, there are convertible and callable securities that are variations of the corporate ones. A zero coupon bond is another type that pays no interest. It is offered at a discount, and investors earn interest at maturity. They are paid a lump sum which covers the interest and amount of the initial investment.
Debt securities are issued by national, municipal, and other authorities. There are inflation-indexed, exchangeable, high-yield, perpetual, covered, subordinated, and other varieties. Subordinated bonds are risky in that they have a lower priority than senior debt securities. This means that in case of bankruptcy, other creditors are paid first. Equity-linked bonds are indexed on GDP or another indicator and are backed by one or several securities. Issuers offer equity products in the form of certificates of deposit, mutual funds, annuities, and others. They may have a cap on the amount earned. There are also asset backed securities such as collateralized debt and mortgage obligations and mortgage backed securities. Cash flows are used as collateral.
Other instruments include build America, bearer, retail, dual currency, revenue, serial, and types. Revenue bonds, for example, are backed by revenues from some municipal project like highway or toll bridge. This is a formal legal contract between an issuer and holder, and the debt is used to finance the construction of power plants, seaports and airports, and other facilities. Lottery bonds are offered by governments and come with a fixed rate. They are redeemed on a random basis. There are also securities such as war, climate, book entry, fixed rate, floating rate notes, and others.
Components, Features, and Benefits
The main features are the coupon, maturity, principal, market price, and yield. There are instruments with a long, medium, and short term. Medium–term securities have a term of 6 – 12 years and are called notes. T-bills are issued by the government and are easy to understand. The par value is paid at maturity, and the difference between the amount paid at maturity and the initial price is equal to the interest earned. The main advantage for holders is that this is an affordable investment instrument. Denominations vary greatly, from $1 million to $1,000. This is a risk-free product. The downside is that T-bills offer a lower interest rate than products such as money market funds, CDs, and corporate securities. Bills have a short term of 1 – 5 years while those that mature within a period of 1 year are money market instruments.
The interest rate offered by different products is actually the coupon. Most debt securities offer a fixed interest rate, but there are complex products that are linked to some market index. The yield is another feature that indicates the rate of return. It can be in the form of redemption or current yield. The former is an indicator that takes into account different factors such as timing, market price, and others.
Some bonds are putable while others are callable. Issuers of callable securities offer call premiums in some cases and repay the principal before the term. There are products with one call date and instruments with several call dates. The rating is also an important feature. As a rule, junk bonds are very risky and speculative while investment grade securities are safe.
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