The bond market provides a wide range of investment opportunities for people looking to diversify their investment portfolios. While bonds are some of the most reliable investment vehicles, an investor should have a clear understanding of the different types of bonds to make successful moves in the bond markets. Strategy, as well as goals and risk management, should always come into play when selecting the kind of bond to invest in.
A bond being a contract drawn between an issuer (the borrower) and the investor (lender), means any reputable body organization or company can issue it. Below are some of the most popular types of bonds in the bond markets.
Sovereign Government Bonds
Issued by sovereign governments, they are the most popular and most sought after bonds in the market. Such types of bonds include Treasury bills bonds as well as notes backed by a country’s reserves. While the national government can, issue, sovereign bonds government departments, as well as agencies, can also issue such types of bonds to raise capital to meet various financial obligations.
Sovereign government bonds are some of the safest as the government acts as the guarantor on interest payments. However, they are some of the weakest when it comes to profits.
Issued by state and local governments, Municipal bonds are also popular in part because they come with tax benefits in some jurisdictions. The tax benefits are used to entice investors as municipals seek to raise money to fund infrastructure development.
The tax benefit aspect is one of the reasons why Municipal bonds tend to offer lower yields and returns compared to other taxable bonds.
Read More: What Are Bonds, and How Do They Work?
Corporate Bonds are a special type of bond issued by a corporation as well as limited liability companies and partnerships. Such types of bonds stand out in part because they offer higher yields in the form of interest payments.
However, they do not come with tax benefits, as is the case with Municipal bonds. The fact that they might require a holder to pay up to 40% of total interest to Federal or state government in taxes at times makes them undesirable.
A foreign bond is a special type of bond issued in a domestic market by a foreign entity. It differs from the other bonds in that it trades in a foreign currency and foreign financial market. These types of bonds provide leeway for diversifying a portfolio and gaining interest in different currencies. However, they come with their fair share of risk as returns often depend on forex exchange rates.
Convertible bonds are a special type of corporate bonds in which a holder can convert, at any time, his or her holdings to shares of a company, which is the issuer of the bond. They stand out in part because they offer higher yields and carry a stock conversion option. However, they come with lower interest rates compared to other corporate bonds.
How to Invest In Bonds
Bonds, unlike other financial derivatives, are not traded on public exchanges. Instead, they are traded over the counter, which means would-be investors must open accounts with authorized brokers to buy bonds. Treasury bonds differ from other bonds in that one must purchase them directly from the U.S government through middlemen.
The fact that bonds do not trade in public exchange makes it difficult for investors to get a fair price. For instance, a broker might opt to sell a bond at a premium price compared to other brokers.