Definition: A Bond is a contracted debt that obligates the borrower to pay periodical interest (except zero coupon bond) and to repay principal at maturity to lender.
The borrower is the issuer of the bond,the lender is the bondholder.
The bond is always issued with stated par value,interest rate,and the maturity.
If the price of the bond falls under par value when trading in the market it is termed discount bond;if the bond is traded higher than par, it is termed premium bond.
Based on time to maturity there are short bonds (or short term bonds-bonds will mature in two years or less),medium term bonds- bonds will mature in two to ten years,and long bonds (long term bonds- bonds will mature in more than ten years.)
Based on added “call/put” feature in a bond contract there are callable bonds(bonds may be called to redemption at a given date by issuers) and put featured bonds-bonds can be redeemed by bondholders at a given price before maturity.
Classification of bonds: there are so many kinds of bonds and too many terms attached to the word “bond”; so, confusion is inevitable.Fortunately,there are
a few standpoints to base on to classify them with certain clear cut.
Based on the issuers there are two sectors- private and public (government) entities.So,if a bond is issued by a private corporation,it is called corporate bond.If a bond is issued by a state or local government,it is called municipal bond or munis for short.For federal level,it is generally called U.S. Government bond in which Treasury bond is used for bond issued by the Department of Treasury and Federal Agency bond is used for bond issued by a federal agency.
Based on structures: there are three kinds of bonds: term bonds,serial bonds,and series bonds.
Term bonds: bonds of an issuance where all have the same interest and maturity.Corporations and U.S. Government typically issue bonds in this way.
Serial bonds: bonds of an issuance in which the total quantity of bonds is divided into certain “groups”,each group has a different interest rate and different maturity.Municipal bonds are usually fall into this type.
Series bonds: bonds are issued under the same authorization but on different date of issuance with all having the same maturity.
Based on credit ratings: there are investment grade bonds and speculative bonds (commonly known as junk bonds).
Bonds are rated by the three major securities rating companies: Standard and Poor’s,Moody’s,and Fitch.The following is the basic ratings by Standard & Poor’s and Moody’s:
For investment grade bonds,from high to low:
*Standard & Poor’s: AAA, AA, A, BBB
*Moody’s: Aaa, Aa, A, Baa
For junk bonds:
*Standard & Poor’s: BB, B, CCC, CC, C
*Moody’s: Ba, B, Caa, Ca, C
Sub-Classification of bonds: to have a better grip of the variety of bonds,bonds that are classified based on kinds of issuers as shown above (corporate bonds,municipal bonds,and U.S. Government bonds) will be chosen to sub-classify into more specific types of bonds.
Types of Corporate Bonds:
Based on the security of debts,corporate bonds are divided into secured and unsecured bonds.Secured bonds include mortgage bonds-that are bonds pledged by real estate;mortgage bonds can be divided into senior and junior bonds( first and second mortgage bonds).
Note that some corporate debts have the same characteristics of a secured bond but termed by other name such as Equipment Trust Certificate-a debt security pledged by company’s equipments.
Unsecured bonds or debenture: debts are solely pledged by issuer’s full faith and credit.If the bonds can convert to stocks at a given date then they are called convertible bonds.Most unsecured bonds are rated as junk.If the interest payment and principal are guaranteed by another company (usually the parent company) then the bonds are called Guaranteed Bonds. Bonds of a corporation in reorganization (emerging from bankruptcy) are called Income Bonds or Adjustment Bonds.
Next to corporate bonds are municipal bonds.Munis consist of about 45% of General Obligation (G.O.) Bonds,45% of Revenue Bonds and 10% of special type. G.O. bonds are backed by full faith,credit,and taxing power of the issuer. Revenue bonds are backed by a specific source of revenue;full faith,credit,and taxing power are NOT pledged by the issuer.Special types of munis include: Special Tax Bonds,Special Assessment Bonds,Moral Obligation Bond,Double-Barreled Bond,Lease Rental Bond,and Industrial Development Bond.
Now come to the largest borrower : U.S. Government. U.S. Government bonds include bonds issued by Treasury like 30-year Treasury (T-Bonds),TIPs-Treasury Inflation Protection Securities,and STRIPS-Separate Trading of Registered Interest and Principal of Securities. Federal Chartered Agencies (banks) issue bonds implicitly backed by Federal Government like FHA bonds (Federal Housing Administration) TVA bonds (Tennessee Valley Authority) and some issues Pass Through or CMO-Collateralized Mortgage Obligation but these ones are not bonds by definition because they have different debt and repayment structures.
After all another type of bonds that can’t be skipped is international bonds or bonds issued by foreign countries.Except Eurodollar Bonds most other foreign bonds do not attract attention from investors due to the unregulation,the currency exchange risk,political unstability,creditability,etc.Eurodollar bonds are rooted from Euro bonds and denominated in dollars;they are getting more and more attention from corporations,municipalities due to lower cost of issuance and regulation,they also get more attention from U.S. investors due to some advantages in tax rule and trading regulation.
With such a level of complexity and variety trading or investing in bonds
certainly requires studies and hard work.