Types of Fixed Income Securities
There are a few types of Fixed Income Securities.
Corporate bonds (also called corporates) are debt obligations, or IOUs, issued by private and public corporations. They are typically issued in multiples of $1,000 and/or $5,000. Companies use the funds they raise from selling bonds for a variety of purposes, from building facilities to purchasing equipment to expanding the business.
When you buy a bond, you are lending money to the corporation that issued it, which promises to return your money, or principal, on a specified maturity date. Until that time, it also pays you a fixed rate of interest, usually semiannually.
The interest payments you receive from corporate bonds are taxable. Unlike stocks, bonds do not give you an ownership interest in the issuing corporation.
Municipal bonds are debt obligations issued by states, municipalities and various public authorities to raise money to build schools, highways, hospitals, and sewer systems, as well as many other projects for the public good. When you purchase a municipal bond, you are lending money to an issuer who promises to pay you a specified amount of interest (usually paid semiannually) and return the principal to you on a specific maturity date. The interest is usually exempt from federal income tax and state and local taxes, if issued in the state of the holder’s residence.
Certificates Of Deposit (CD)
A negotiable money market instrument issued by banks against money deposited with them for a specified period of time. CDs vary in size according to the amount of the deposit and the maturity period. In general CDs may be redeemed before maturity only by sale on the secondary market.
Government bonds (also called Treasurys) are securities (bonds, notes or bills) issued by the U.S. government.
A Treasury bill is a certificate representing a short-term loan to the federal government that matures in three, six or 12 months.
A Treasury note matures in two to 10 years.
A Treasury bond matures in 10 years.
Among bonds, the 30-year issue is considered a key indicator of trends in long-term interest rates.
Zero Coupon Bonds
Zero coupon bonds are bonds that do not pay interest during the life of the bonds. Instead, investors buy zero coupon bonds at a deep discount from their face value, which is the amount a bond will be worth when it “matures” or comes due. When a zero coupon bond matures, the investor will receive one lump sum equal to the initial investment plus interest that has accreted. Investors can purchase different kinds of zero coupon bonds in the secondary markets that have been issued from a variety of sources, including the U.S. Treasury, corporations, and state and local government entities.
Because zero coupon bonds pay no interest until maturity, their prices fluctuate more than other types of bonds in the secondary market. In addition, although zero coupon bonds do not pay any interest until they mature, investors may still have to pay federal, state, and local income tax on the imputed or “phantom” interest that accrues each year. Some municipalities issues zero coupon bonds that are federal and state tax free. Zero coupon bonds can be purchased in a tax deferred account such as an IRA.