If you think of diversifying your portfolio while maintaining a stream of revenue, Investing in Bonds would be an ideal choice. Since bonds are fixed-income securities, they represent a comparatively lower-risk investment than equities.
It is extremely useful for investors to have a basic understanding of the types of bonds available to the market because this may help them choose the type of security that suits their investment objective and risk profile.
7 Main Types of Bonds
Here are the seven main types of bonds every investor should be in the know about:
1. Government Bonds
Also referred to as sovereign bonds, government bonds are issued to finance the construction of schools, roads, and other infrastructure or to cover up debt deficits. They are also regarded as one of the risk free investment opportunities because such bonds are guaranteed by the credit of the government.
Why Invest: Security and guaranteed profits.
Example: US Treasury Bonds (T-Bonds), G-Secs (India).
2. Corporate Bonds
Organizations looking to finance their development issues bonds in order to collect resources.
Types:
Secured Bonds: These bonds are guaranteed by properties.
Unsecured Bonds: There is no collateral provided however there is the assurance of timely repayment.
Why Invest: These are riskier than government bonds but provide substantial rewards
3. Municipal Bonds
Local authorities or municipalities are the ones who issue these bonds to raise funds for public undertakings which comprise the building of schools, roads, hospitals etc.
Tax Advantage: There is a recurrent variable which many municipal bonds sustain that is tax-free income.
Why Invest: Those who have an appetite for moderate risk and want to invest in tax advantaged schemes will find this useful.
4. Zero-Coupon Bonds
These bonds are issued and sold at a price lower than their face value. Also, coupon payments do not occur during the lives of the bonds. When the bonds mature, the owner receives the entire principal amount.
Why Invest: These are great for long term goals like retirement or education savings.
Risk: These investments exhibit substantial price fluctuations alongside the movement of interest rates.
5. Convertible Bonds
Convertible bonds are given the special privilege to investors that they can exchange their bonds for specified shares of the firm.
Why Invest: Because they provide regular income and additional scope for growth through equity.
Best For: Investors seeking steady returns with slight inclination to the company’s future growth prospects.
6. High-Yield Bonds
High yield bonds also referred to as “junk bond” have been rated below “BB” by the various rating agencies.
Why Invest: The expected returns are high.
Risk: These bonds are subject to a very high chance of default. Only for high-risk investors.
7. Floating Rate Bonds
These are bonds with fixed rate of interest paid semi-annually, but with the rate changing from one period to another depending on the market rate.
Why Invest: A safeguard against the threat of interest rate increases.
Example: Bonds issued in relation to LIBOR or SOFR.
Conclusion
Market fragmentation and risk-taking can be easily contained by incorporating bonds into an investment strategy, however, their underlying structure can be complicated to comprehend.
There’s a lot of literature available regarding the many categories of fixed income securities, while also getting interested in individual and defined bonds.
All of them share the same goal, but differ in conveyance. Understanding the nature of bonds can come in handy, especially for those who prefer more liquidity and are willing to diversify a bit more.
Bonds usually serve as a reliable option for companies on the verge of expanding their market. Hence, investing in matured bonds where market saturation has been achieved is not quite a risk-free endeavour and may not guarantee any returns.