Recognizing different types of bonds

Bonds come in all shapes and sizes, and they enable you to
choose one that meet your needs in terms of your investment
time horizon, risk profile, and income needs. First, here is a
look at the different types of U.S. government securities that
are available:

 Treasury bills: T-Bills: T-Bills have a minimum purchase
price of $10,000 and are offered in 3-month, 6-month,
and 12-month maturities. T-Bills do not pay current
interest, but instead are always sold at a discount price,
which is lower than par value. The difference between
the discount price and the par value received is considered
interest. For example, if you pay the discount price
of $9,500 for a $10,000 T-Bill, you pay 5% less than you
actually get back when the bill matures. Par is considered
to be $10,000.

 Treasury notes: Treasury notes have maturities of 2 to
10 years. The minimum investment is $1,000, but they
are also issued in $5,000 and $10,000 amounts. Treasury
notes have coupons that pay interest every six
months.

 Treasury bonds:With maturities of up to 30 years, these
are the long-term offerings from the Treasury Department;
as such, these bonds typically pay the highest
interest. The minimum investment is $1,000, but they
are also issued in $5,000 and $10,000 amounts. Treasury
bonds have coupons that pay interest every six
months.

 Zero-coupon bonds: Zero-coupon bonds do not pay
current interest. You buy the bond at a steep discount,
and interest accrues (builds up) during the life of the
bond. At maturity, the investor receives all the accrued
interest plus his/her original investment. Zero-coupon
bonds are taxed each year on the interest earned (even
though it’s not actually paid out), unless it is a zero-
coupon municipal bond (which would be free of federal
and possibly state taxes.) Zero-coupon bonds are usually
used in IRA accounts.

 Savings bonds: These have been the apple pie of American
investing for years. They act like zero coupon bonds,
but you can purchase them in small denominations from
banks or the Treasury Department. For more zest, the
agency began offering inflation-indexed bonds in 1998,
which guarantee that your return will outpace inflation.
The bond’s yield is actually based on the inflation rate
plus a fixed rate of return, such as 3%. Interest on savings
bonds is not taxed until the bond is cashed in.
Financial experts generally see United States government
bonds as the safest investment bet around. But remember
that risk and reward are tradeoffs that you need to
look at in tandem. As with all investments, the safer the
investment, the less you’re likely to earn or lose!

The following are other types of available bonds:

 Municipal bonds: These are loans you make to a local
government, whether it’s in your city, town, or state.
Because most are free from local (if you live in the
municipality issuing the bond), state (if the municipality
issuing the bond is in your state of residence), and
federal taxes, they can be valuable to those who seek tax
relief —
often folks in higher income tax brackets. Generally,
these bonds have proven their worth as safe
investments over the years (although there have been a
few instances when municipalities proved unreliable);
they pay a stated interest rate over the life of the bond.
Some municipal bonds are insured, making them safe
from default. Municipal bonds are generally available at
minimums of $5,000.

 Corporate bonds: These are issued by companies that
need to raise money, including public utilities and
transportation companies, industrial corporations and
manufacturers, and financial service companies. Minimum
investment in corporate bonds is $1,000.

Corporate bonds can be riskier than either U.S. government
bonds or municipal bonds because companies can
go bankrupt. So a company’s credit risk is an important
tool for evaluating the safety of a corporate bond. Even
if an organization doesn’t throw in the towel, its risk factor
can be enough to cause agency analysts, such as Standard
& Poors or Moody’s, to downgrade the company’s
overall rating. If that happens, you may find it more difficult
to sell the bond early.

 Junk bonds: Junk bonds pay high yields because the
issuer may be in financial trouble, have a poor credit rating,
and are likely to have a difficult time finding buyers
for their issues. Although you may decide that junk
bonds or junk bond mutual funds have a place in your
portfolio, make sure that spot is small because these
bonds carry high risk.

Although junk bonds may look particularly attractive at
times, think twice before you buy. They don’t call them junk
for nothing. You could potentially suffer a total loss if the
issuer declares bankruptcy. As one wag suggested, if you really
believe in the company so much, invest in its stock, which
has unlimited upside potential.