Most of the time when people think of investments, they think of two things: stocks and bonds. Last week I discussed stocks and this week will be bonds.
Bonds are debt issued by a business or a government. With stocks, the share holder owns a portion of the business. With bonds, however, the bond holder does not own any part of the issuing business or government body. The bond issuer will periodically make interest payments to the holder, usually every six months. At maturity date, which could range from a few years to 30 years, the issue will return the bond at par value ($1000/bond).
Bonds are rated on a scale. Where they lay on that scale will depend on their financial ability to make interest payments and pay back the principal (the amount paid for the bond). The ratings are as follows: AAA, AA, A, BBB, BB, B, CCC, CC, C, and D.
U.S. Treasuries (Federal Government Bond)
These are bonds issued by the federal government. These bonds are backed by the full faith and credit of the U.S. Government, so they are said to be “credit risk free.” The United States is AAA rated and always has the power of taxes to meet future debt obligations. Because they are “risk free,” the interest payments are low.
These bonds are issued by federal government agencies, but they are not backed by the full faith and credit of the U.S. Government. They are still AAA rated, but like Treasuries, their interest payments are lower.
Municipal bonds are issued by state and local governments. These bodies of government are usually safe, similar to the U.S. Government, but there are some, like the State of Illinois, that are drowning in debt and have failed to meet debt obligations. When these things happen, the credit rating goes down. Most states and local governments generally have a high rating, but Illinois is now BBB rated.
Corporate bonds are issued by businesses. The credit rating and interest payments will depend on the financial strength of the business. A top company like Apple or Exxon Mobile should have a higher rating than a small, young startup in Silicon Valley. Though, small startup should make bigger interest payments because there is more risked assumed by the investor.
There are many different types of bonds, all of which have their different sets of advantages and disadvantages. The companies and government bodies that have the ability to make interest payments and principal payments should be rated higher, but should also pay less in interest payments to the investor.
The companies listed about are not to be taken as an endorsement or recommendation. All investments come with risk. Use your risk tolerance, time horizon, and investment objectives when making investment decisions. Please consult with a financial professional before investing.