WHAT ARE BONDS AND HOW TO INVEST IN THEM​

A bond is a loan made to a company or government in exchange for income. The income is typically paid out on a regular basis and is commonly referred to as a coupon payment.​

The amount of money a bond issuer borrows is commonly referred to as the principal amount. The bond's maturity date is when the principal amount is scheduled to be repaid to investors. Ultra-short term bonds will mature between 0-6 months, short-term bonds will mature within 1-3 years, intermediate-term bonds will mature between 4-10 years and anything beyond is considered a long-term bond.​

Another term you may have come across is yield, which is the annual expected return on a bond, expressed as a percentage rate. Yields move inversely with bond prices, which typically fall when interest rates rise.

These are the main types of risks you should be aware of:​

1. Interest rate risk: Interest rate risk is the risk of a bond’s price falling as interest rates rise. A bond’s price and its yield move in opposite directions. Duration is one indicator of how sensitive a bond’s price is to changes in interest rates. The longer the duration, the greater the change of a bond’s price may be in response to a change in interest rates. ​
2. Credit risk: The risk of a default, meaning the company or government that issued a bond can’t (or won’t) pay investors back. The credit rating of a bond issuer measures its willingness and ability to pay back lenders. The higher the credit rating, the lower the credit risk. ​
3. Liquidity risk: The risk there isn’t anyone in the market willing to buy your bonds if you wish to sell and vice versa. ​
4. Inflation risk: The risk that inflation could  erode the value of the interest payments of your bonds.

 The four most common types of bonds:​

• Government bonds: Issued by governments to fund government spending or pay existing debt. U.S. government bonds, aka "Treasuries", are generally considered to be the safest investments, because they are backed by the full faith and credit of the U.S. government. In other words, the probability that you won't get paid back is generally viewed as very low.​
• Corporate bonds: Issued by corporations to raise money for different purposes. Corporate bond yields tend to be higher than government bonds to compensate investors for the increased risk that companies won’t pay you back. There are two main types of corporate debt:​
  • Investment grade, which have lower credit risk ​
  • High yield: which have higher credit risk, compensated by higher yields​
• Municipal bonds: Issued by states, cities, counties or local government entities. Income from municipal bonds is exempt from federal taxes; some 'munis' are also free from state and local taxes.​
• Emerging market (EM) bonds: Issued by government or corporations in developing countries. EM bonds tend to yield more than U.S. bonds with similar credit qualities to compensate investors for the additional risk.​

​Taxable vs. tax-exempt bonds: Most bonds are taxable, meaning the income that bonds produce is taxable. On the other hand, the income from tax-exempt bonds, like tax-exempt municipal bonds, may be exempt from Federal, state, and local taxes.

​Municipal bonds: The most common type of tax-exempt bonds, Municipal bonds are issued by local government entities like states, counties, or municipalities. Some municipal bonds are not taxed at the Federal level and may even be exempt from state and local taxes.​ Municipal bonds are, however, subject to alternative minimum tax.​

​Treasury Bonds: Bonds issued by the U.S. government, which are backed by the full faith and credit of the U.S. government and are considered credit risk-free.​

​Emerging Market (EM) Bonds: Bonds issued by governments or corporations in developing countries. EM bonds tend to generate greater returns than U.S. government or corporate bonds to compensate investors for additional risk.​

​Investment Grade Corporate Bonds: A bond issued by a company to raise money for various purposes and has been rated by an independent credit rating agency to be high quality (Baa/BBB or higher).​

​Floating Rate Notes: A bond that has a variable coupon that periodically resets based on a short term interest rate, such as the Secured Overnight Financing Rate (SOFR) or the yield on 3-month Treasury bills.​

​TIPs and Inflation Protected Bonds: Treasury Inflation-Protected Securities or TIPS, are issued by the U.S. Department of Treasury and their value adjusts with inflation, helping you protect the value of your money.​

​MBS: Mortgage-backed securities (MBS) are formed by bundling home mortgages together. Mortgages issued by a bank are pooled together and sold to government sponsored-enterprises or to a securities firm to be used as collateral for the new mortgage-backed security. Most MBS are issued or guaranteed by government-sponsored entities, such as Ginnie Mae, Fannie Mae, or Freddie Mac.​

​CMBS: Similar to MBS, commercial mortgage-backed securities (CMBS) are formed by bundling commercial property mortgages like office buildings, apartment buildings, and hotels. Unlike MBS, CMBS are not guaranteed by government entities. ​

​ABS: Asset-backed securities (ABS) are pools of loans bundled together and sold to investors. The types of loans in ABS include mortgages, auto loans, home equity loans, student loans, and credit card receivables.​