Differentiate between the three types of bondsSolutionThere

Differentiate between the three types of bonds.

Solution

There are three basic types of bonds: U.S. Treasury Securities, municipal bonds, and corporate bonds.

Treasury Securities

Bonds bills and notes issued by the US government are called the Treasuries and are of highest quality safe types of bonds.

All these treasuries are liquid and traded on the secondary market. Interest earned on these bonds are tax exempt from the local and state government. These bonds are backed by the US Governments.

Treasury Bill – These are short term securities and matures in less than a year. These assets don’t pay interest before maturity.

Treasury Notes – These bonds have maturity period of 1 to 10 years. It earns fixed rate of interest after every six months.

Treasury Bonds - These bonds have maturity period of 10 to 30 years. It also earns fixed rate of interest after every six months.

Municipal bonds

Municipal bonds are issues by the federal, state, city or town government to fund the various civil project for the betterment of society and to improve the economy. Municipal bonds are debt securities issued by local civic institutions to the bondholders. These are traded on the secondary market. Bondholders get share of profit from these project in terms of coupon rate. Interest are paid on every six months till the maturity date. Interest earned from these bonds tend to be tax free from ordinary income tax but may subject to the state or federal tax.

So, on maturity bondholder receive half yearly interest and face value of the bond.

Corporate bonds

Corporates issue bond to fund large capital requirement for the operations or investment purpose of the organization. These bonds are graded as per the credit risk and expected return. High volatile bond which are also known as Junk bond provides high yield. These bonds carry significant risk to the bondholders. Variations on corporate bonds include convertible bonds, which can be converted into company stock under certain conditions. There is also zero-coupon bond. These bonds don’t make any coupon payment but issued at high discount rate and at its full value upon maturity.