Bonds represent debt obligations – and therefore are a form of borrowing.You loan your money to a company, a city, the government – and they promise to pay you back in full, with regular interest payments.
Types of Bonds
Government bonds can be issued by national governments as well as by the lower levels of government. At the national or federal level, these government bonds are known as “sovereign” debt, and are backed by the ability of a nation to tax its citizens and to print currency.
The other major issuer of bonds are corporations, and corporate bonds make up a large portion of the overall bond market. Large corporations have a great deal of flexibility as to how much debt they can issue: the limit is generally whatever the market will bear. A corporate bond is considered short-term corporate bond when the maturity period is less than five years; intermediate is five to 12 years, and long-term is over 12 years.
A third category of bonds is issued by banks or other financial sector participants and are referred to as asset-backed securities or ABS. These bonds are created by packaging up the cash flows generated by a number of similar assets and offering them to investors.These bonds are typically reserved for sophisticated or institutional investors and not individuals.
Benefits of Bonds
- Reliable- Bonds are a reliable source of current income depending on the structure of the bond you invest in.
- Liquidity- The bond market is large and active and provides an element of liquidity.
- Exempt from taxation- Interest income from federal government bonds is exempt from taxation at the state and local level, and the interest income from municipal bonds is usually not subject to federal tax.