Types of Bonds You Can Buy, Sell, and Invest in 2020

The multi-trillion dollar bond space is home to many different bond types. At the forefront of this is corporate bonds and government bonds, as well as bonds issued by state and city authorities. With that said, each bond type comes with its own pros and cons.

For example, some bonds are highly liquid, meaning you stand a much better chance of being able to sell them before maturity. In other cases, some bonds allow you to exchange your holdings for equity in the company that issued them.

In this article, we cover the main bond types currently available in the financial markets, how they work, and what you need to know prior to making an investment.  We’ll also explain how you can buy your chosen bond type as a retail investor.

Types of Bonds: Overview

Below we have listed the bond types that we discuss in this guide. Scroll down to find out how each bond type works in practice.

• Corporate Bonds: Issued by publically-listed companies
• Government Bonds: Backed by nation-states
• Treasury Bonds: Issued by the US Treasury Department
• Municipal Bonds: Bonds issued at a state, city, or regional level
• Convertible Bonds: Bonds that can be converted into equity, debt, or cash
• Bond ETFs: Speculate on the future value of bonds without owning the asset
• Bond Funds: Mutual funds buy and sell bonds on your behalf

Bonds: The Basics

Before we delve into the many different bond types currently circulating around the financial markets, it’s well worth looking at some of the similarities that all bonds will have. This centres on key characteristics such as the coupon rate, maturity, face value, and running yield. Whether its government bonds, convertible bonds, or municipal bonds, all bond types will carry the aforementioned metrics, so let’s explore how they work.

Bond Coupon Rate

Firstly, when bonds are issued by governments or corporations, they will come with a coupon rate. This is the amount of interest that the bond issuer is willing to pay you as an investor for lending it money. Think of it like the APR rate on a loan, but in reverse.

• For example, let’s say that a company listed on the New York Stock Exchange (NYSE) wishes to raise $400 million, so it issues some bonds.
• In doing so, the company offers a coupon rate of 5%
• This means that you will be paid 5% in interest annually on every bond that you hold
• Payments will continue until the bonds mature, which will be for a fixed number of years

It is important to note that the coupon rate on bonds will never change. This allows you to earn passive income in its truest form, as you will always know exactly how much your money will grow by.

Bond Face Value

All bond types will come with a face value. This is the amount of money that you need to pay to purchase each bond. Sticking with the same example as above where a company issues $400 million worth of bonds, let’s say that this consists of 400,000 individual bonds.

This means that the face value of each bond is $1,000. We know this because $400 million was issued in total, which we then divide by 400,000 individual bonds. Although the face value of bonds will never change, the running yield can.

Bond Maturity

The maturity on a bond simply refers to its term. As we noted above, bonds operate like a loan, as you are lending money to the issuer. As is the case with all loans, the financing agreement will come with a term – for example, 2, 3, or 5 years. This is exactly how the maturity on bonds work, as the issuer will need to borrow the funds for a pre-determined number of years.

• For example, let’s say that you invest $ 5,000 in bonds with a maturity of 7 years
• The bonds pay a coupon rate of 5%, which is distributed once per year
• This means that you will receive 5% in interest payments annually until the bonds mature 7 years later
• At the end of the 7-year term, you will receive your original $5,000 back
• The maturity term of a bond will never change

Bond Running Yield

Although the running yield also refers to the amount of interest you will make on your bond investment, it actually differs to the coupon rate. This is because the coupon rate remains fixed until the bonds mature. However, the yield will go up and down depending on market conditions.

• For example, if the bonds were issued by a government based in a country with a growing economy, the value of the bonds will go up in the secondary market.
• This means that the yield will go down, as the risks of the bonds are lower. This would allow you to sell the bonds at a premium on the secondary market.
• If the risks of the bonds go up, the yield will increase. This means that you would need to sell your bonds at a discount in order to attract new buyers.

Bond Issuers

Regardless of which bond type you are looking to invest in, the issuer of the bonds can only fall within one of two categories; corporate bonds or government bonds. If the bonds are issued by a governmental body, this might include the US government or the state of New York. If they are issued by a corporation, this will be a publically-listed company such as Apple, Nike, Ford Motors, or Disney.

Corporate Bonds

Corporate bonds are issued by large companies as a means to raise cash. This might be to fund a new venture or to help pay for a new acquisition. Either way, just because the company is looking to raise cash, this doesn’t necessarily mean that it is facing cash flow issues.

On the contrary, companies of all financial standings issue bonds, as they allow firms to raise cash without giving away more equity in the form of shares. For example, Apple, an organization with billions of dollars in cash reserves, recently engaged in a bond issue of its own.

• The yields on corporate bonds will vary considerably depending on the financial standing of the company issuing them
• This is because investors need to be rewarded with higher returns as the risks of default increase
• Corporate bonds are usually issued directly to the institutional space, so retail investors need to purchase them from a third-party broker
• Corporate bonds are risker than US Treasury bonds, as companies do not have the backing of the Federal Reserve
• Although a secondary marketplace does exist for corporate bonds, it’s a lot less liquid than government bonds

How to Buy Corporate Bonds

If you want to buy corporate bonds today, follow the quickfire step-by-step guidelines outlined below.

• Step 1: Find an online broker that lists the corporate bonds you wish to buy
• Step 2: Open an account and verify your identity
• Step 3: Deposit funds
• Step 4: Purchase corporate bonds and receive coupon payments every 6 or 12 months
• Step 5: Receive your original investment back once the bonds mature

Read More: How do corporate bonds work?

Government Bonds

As the name suggests, government bonds are issued by governmental bodies. This is usually by nation-states that wish to raise cash to help fund key frontline services.  For example, let’s say that the US government needs to raise an additional $4 billion to cover a shortfall in tax revenues. By issuing bonds, it allows investors to make a fixed rate of interest until the bonds mature.

• The yields on government bonds will ultimately depend on the nation’s underlying economy. For example, the yield on US government bonds will be significantly lower in comparison to government bonds issued by Russia or Brazil
• The secondary marketplace on government bonds is highly liquid, especially if the bonds are backed by a leading currency such as the US dollar, British pound, or the Euro
• Governments have the luxury of printing more money if they are unable to cover upcoming bond payments
• However, if the bonds were issued in a currency that differs from the issuers, printing more money is not an option
• For example, the likes of Venezuela recently defaulted on their government bonds as they were denominated in US dollars

How to Buy Government Bonds

If you want to buy government bonds, you will normally need to buy them directly from the issuer. You usually need to be a resident of the country in question. For example, if you want to buy UK government bonds, you’ll need to be a UK taxpayer. If you don’t meet this requirement, you’ll need to consider a government bond ETF or fund, which we cover further down in our guide.

• Step 1: Go the website of the government bond issuer (for example the US Treasury Direct website)
• Step 2: Open an account and verify your identity
• Step 3: Deposit funds
• Step 4: Purchase the government bonds and receive coupon payments every 6 or 12 months
• Step 5: Receive your original investment back once the bonds mature

Treasury Bonds

Treasury bonds are merely government bonds issued by the US Treasury. Often referred to as T-Bills, Treasury bonds come with a range of yields and maturity terms.

Much like any other government-issued bond in the market, the value of the bond will go up and down depending on the strength of the US economy.

In times of economic uncertainties, investors often flock to US Treasury bills as they act as a low-risk safeguard against falling stock prices.

Check out the current yields offered by US Treasury bonds as of March 2020.

• 6-months: 1.54%
• 2-years: 1.42%
• 5-years: 1.41%
• 10-years: 1.57%
• 30-years: 2.01%

If you’re a US citizen or permanent resident, you can buy Treasury bonds directly from the Treasury Office website. You simply need to open an account, verify your identity, and then transfer funds from your US checking account. Bonds are sold in denominations of $100 instruments, and coupon payments will be paid directly into your Treasury Office account.

Read More: How do US Treasury bonds work?

Municipal Bonds

Municipal bonds are issued by government authorities, but at a local level. This includes the state itself, or by a city or local region. The bonds are issued with the view of raising money to pay for local services, or to cover a shortfall in tax revenues. Unlike US Treasury bonds, municipal bonds are not backed by the Federal Reserve.

This means that the risks of default are much higher. At the same time, the yields on municipal bonds are a lot more attractive than Treasury bonds, so you need to weigh up the risks and rewards of the bonds in question. In order to purchase municipal bonds, you’ll have two options.

• Buy Municipal Bonds Directly: In most cases, the state, city, or region will issue bonds directly to institutional investors. This is because it is more efficient to sell the bonds in large lot sizes, as opposed to individuals with local investors. With that said, you might be able to buy municipal bonds locally from your bank, or through a third-party broker.
• Invest in a Municipal Bond Fund: The other option available to you is to invest in a municipal bond fund. You will be investing your money with a large-scale mutual fund provider, who will then buy and sell thousands of municipal bonds on behalf of its investors. You will then be entitled to your share of coupon payments, and any capital gains made from selling the bonds at a profit. This option is ideal if you want to benefit from passive income.

Read More: How do US municipal bonds work?

Convertible Bonds

Convertible bonds are a more complex bond type that is typically reserved for the institutional space. As such, unless you have access to a large amount of capital, you likely won’t be able to purchase convertible bonds directly. Instead, you’ll need to use a third-party broker or a mutual fund.

In terms of how the bonds work, convertible bonds allow you to ‘covert’ your bonds into equity, debt, or cash. The specifics regarding when and what you can convert the bonds into will vary depending on the type of convertible bond you hold.

• Vanilla Convertible Bonds: This convertible bond-type allows you to convert your bonds at any given time. When you do, you will receive equity in the company via shares. Vanilla bonds are great because you can wait until the value of the shares goes up before making the conversion. Until then, you will enjoy the fixed yield of interest that the bonds pay.
• Mandatory Convertible Bonds: Mandatory convertible bonds are similar to vanilla bonds, although they will come with an automated redemption date. For example, if the issuer sets a redemption date of 23rd April 2024, and you don’t convert them before this date, the bonds will be exchanged for equity by default.
• Reverse Convertible Bonds: Reversible convertible bonds give more control to the issuer in comparison to vanilla and mandatory bonds. This is because the issuer can convert the bonds whenever they choose to. Crucially, the issuer can also decide what instrument to convert them into. This can be either equity, debt or cash.

As note above – whether its vanilla, mandatory or reverse convertible bonds, access is somewhat limited for retail investors. You will, therefore, need to use a third-party broker where minimum investments will still apply or go through a mutual fund.

Bond ETFs

Exchange-traded funds (ETFs) track real-world assets such as gold, oil, stocks, and bonds. They are ideal for investors that wish to gain exposure to a particular bond market that would other be difficult to access. When you invest in a bond ETF, you won’t actually own the underlying asset. Instead, you are merely speculating on the future value of the bond in question.

Here’s an example of how a bond ETF might work in practice.

1. You invest $5,000 into a bond ETF that tracks the value of 10-year US Treasury bonds
2. The current price of the bond is $102.45
3. You place a buy order, meaning that you think the value of the bond will increase
4. A few days later, the value of 10-year US Treasury bonds is $103.56
5. This represents an increase of 1.08%
6. This amounts to a profit of $54 ($5,000 x 1.08%)

Although bond ETFs typically come without the benefit of coupon payments, as you don’t own the underlying asset, they stand out for a number of reasons, such as:

• Bond ETFs allow you to invest in bonds that would otherwise be difficult to reach, such as foreign government bonds
• Minimum investments are usually very low
• You can also ‘short’ the bonds, meaning you will make a profit when the market value of the bond goes down
• You are not tied to any maturity terms, so you can cash out your investment at any time
• You can also apply leverage to your bond ETF investment, although do tread with caution as this increases the risks of losing money

Read More: How do bond ETFs work?

Bond Funds

Bond funds are large-scale investment houses that buy and sell bonds on your behalf. They operate much like a traditional mutual fund, as your money will be pooled together with other investors. This then provides the fund with a multi-billion dollar portfolio.

The fund manager will purchase bonds on your behalf, meaning that your investment provides passive income. Although bond funds rarely hold onto bonds until they mature, the provider will still receive coupon payments throughout the month. This is because they will hold a basket that contains tens of thousands of individual bonds.

As an investor, you will receive your share of any coupon payments that the fund receives, which is typically paid once per month. On top of regular coupon payments, you will also be entitled to capital gains. This is related to the profits made by the fund when they sell bonds on the secondary markets. Your capital gains will be paid once per year.

In terms of the types of bond that the provider will invest in, this will depend on the fund itself. For example, a low-risk fund that focuses on government securities will like consist of US Treasuries and UK Gilts. A higher-risk fund might hold a mixture of municipal bonds and corporate bonds.

Read More: How do bond funds work?

How to Invest in a Bond Fund

If you want to invest in a bond fund, there are literally hundreds of providers to choose from. You will need to think about the type of bonds that you want to gain exposure to, as well as the risks and rewards of your investment. In terms of how much to expect in yields, a good starting point is to look at the historical returns published by the fund provider.

• Step 1: Choose a bond provider that meets your appetite for risk
• Step 2: Open an account and verify your identity
• Step 3: Deposit money with the bond fund provider
• Step 4: The provider will then invest on your behalf
• Step 5: You will receive your share of coupon payments once per month
• Step 6: You will receive a capital gains payment once per year, based on the profits made by the fund manager when selling instruments in the secondary market
• Step 7: You can typically cash your investment out at any given time, less any fees

Conclusion

By reading our guide all of the way through, you should now have a good understanding of the many bond types available in the market.  Although the choice is plentiful, you will be limited in the types of bonds that you can buy as a retail investor. For example, access to the likes of municipal bonds, convertible bonds, and foreign government bonds is typically reserved for institutional money.

With that said, you can bypass these restrictions by finding a suitable broker, or investing in a bond ETF or fund. Ultimately, whichever bond type you do decide to invest in, just make sure that you mitigate your risks as best as possible. The most effective way to do this is to diversify across several bond types, across multiple markets, industries, and economies.

 

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