General Infomation about Bonds
Bond Glossary
- AMBAC insured: Ambac Indemnity Corporation, one of the companies in the municipal bond insurance business
- AMT: subject to AMT (alternative minimum tax) municipal bonds are those that support projects that are strickly speaking not governmental.
- call:
- coupon: bonds interest payment
- coupon rate: annual interest rate
- dealer price: current price of bond
- dealer yield: yield at call
- extraordinary calls (or extraordinary redemption provision): Provision giving issuer the right to call the bonds due to a one-time occurrence, as specified in the offering statement. The circumstances could range from natural disasters and cancelled projects to almost anything else.
- face value: price at issue or "par value."
- OID - original issue discount: The discount from par value at the time that a bond or other debt instrument is issued. It is the difference between the stated redemption price at maturity and the issue price. OID is considered to be a form of interest, so tax issues can get a bit complicated.
- junk bond: High risk corporate bonds
- sinking fund: A means of repaying funds that were borrowed through a bond issue. The issuer makes periodic payments to a trustee who retires part of the issue by purchasing the bonds in the open market.
- term: Length of time to maturity
- total return: Includes all the money you earn from the bond: the annual interest PLUS the gain or loss in market value, if any.
- yield to call: The yield of a bond or note if you were to buy and hold the security until the call date. This yield is valid only if the security is called prior to maturity. The calculation of yield to call is based on the coupon rate, the length of time to the call date and the market price.
Types of Bonds
- Treasury bills (T-bills): 13 weeks, 26 weeks, and one year. Buy at a discount to their $10,000 face value and receive the full $10,000 at maturity. Interest free of state tax.
- Treasury notes: 2 to 10 years. Interest paid semiannually at fixed rate. Interest free of state tax.
- Treasury bonds: 10 years. Interest paid semiannually. Interest free of state tax.
- Corporate bonds: Varied terms. Carry higher risks, give higher yields than super-safe Treasurys. Top-quality bonds: investment-grade. Lower credit quality bonds: high-yield or junk bonds. Interest fully taxable
- Municipal bonds (munis): America's favorite tax shelters. Issued by state and local governments
denominations of $5,000 and up. Mature in one to 30 or 40 years. Interest exempt from federal taxes and (if you live in the state issuing the bond) state taxes as well. Capital gain is taxable. Munis generally offer lower yields than taxable bonds of similar duration and quality. Because of their tax advantages, though, their after-tax returns are often higher than equivalent taxable bonds for people in the 28 percent federal tax bracket or above.
Risks of Owning Bonds
- Inflation risk: Since bond interest payments are fixed, their value can be eroded by inflation. The longer the term of the bond, the higher the inflation risk. On the other hand, bonds are a classic deflation hedge; deflation increases the value of the dollars that bond investors get paid.
- Interest rate vs bond prices tradeoff: Bond prices move in the opposite direction of interest rates. When rates rise, bond prices fall because new bonds are issued that pay higher coupons, making the older, lower-yielding bonds less attractive. Conversely, bond prices rise when interest rates fall because the higher payouts on the old bonds look more attractive relative to the lower rates offered on newer ones. There is a close connection between inflation risk and interest rate risk since interest rates tend to rise along with inflation. Note that bond price fluctuations only matter if you intend to sell a bond before maturity, or you invest in a bond fund whose manager trades regularly. If you hold a bond to its maturity, you will be repaid the bond's full face value.
- Call risk: Sometimes corporate and muni bond issuers reserve the right to redeem, or "call," their bonds before they mature, at which point the issuer is required to pay bondholders only par value. Typically, this happens if interest rates fall and the issuer sees it can lower its costs by selling new bonds with lower yields. If you happen to own one of the called bonds, not only do you get less than the market price of the bond, but you also have to find a place to reinvest the money. Because of the risk that you won't get the income you expect, callable bonds usually pay a higher rate of interest than comparable, noncallable bonds. So, when you buy bonds, make sure to ask not only about the time to maturity, but also about the time to a likely call.
- Credit risk: This is the risk that your bond issuer will be unable to make its payments on time - or at all - and it depends on the type of bond you own and the borrower's financial health.
- Liquidity risk: In general, bonds aren't nearly as liquid as stocks because investors tend to buy and hold bonds rather than trade them. While there is always a ready market for super-safe Treasurys, the markets for other bonds, especially munis and junk bonds, can be highly illiquid. If you are forced to unload a thinly-traded bond, you will probably get a low price.
- Market risk: As with most other investments, bonds follow the laws of supply and demand. The more popular or less plentiful a bond, the higher the price it commands in the market. During economic meltdowns in Asia and Russia, for example, the price of safe-haven U.S. Treasurys rose dramatically.