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Bonds (also known as fixed income) are some of the most widely used investment vehicles in the world.
The international bond market was estimated at $46 trillion in 2006 and the US bond market was estimated at $25.2 trillion. By comparison, the value of the world stock markets as of October 2006 was estimated at $36.6 trillion. Analysis of returns have shown that over long periods of time, bonds tend to outpeform stocks.
Bonds are a form of debt, similar to an I.O.U. In return for providing a company or a government with a loan, investors receive a promise for a certain rate of return over the term of the loan as well as repayment of the loan when the term ends or it "comes due".
Bonds come in many different shapes and forms and a bond portfolio may include several different types and maturities depending on the objective of the bond holder. Among those bonds that US nationals and US residents are most like to consider are.
You can invest in bonds in two ways.
1. Buy the actual bond. Investors can purchase and hold bonds directly from either the government or a brokerage.
2. Invest in bonds via a bond fund, treasury money market, or other investment vehicle.
Among the safest bonds are U.S. Treasury bills, notes, and bonds. These securities are debt obligations of the U.S. government, the largest debt issuer in the world. Since these debt obligations are backed by the “full faith and credit” of the US government, and thus by its ability to raise tax revenues and print currency, US Treasuries are viewed in the market as having no “credit risk,” meaning that it is virtually certain your interest and principal will be paid on time.
Interest on US Treasuries is ordinarily state and local tax-free.
Treasury bills mature in one-year or less. Treasury notes mature between 2-10 years while treasury bonds, also known as long bonds, mature between 20-30 years.
Series I Treasury Bonds and Treasury Inflation Protected Securities (TIPS) are also issued debt securities of the US government that have some inflation adjusted properties.
Agency Bonds, bonds issued directly by a Federal agency, often offer similar tax features as Treasuries while providing higher yields. While the Federal government has never allowed an agency bond to default, it does not have a legal obligation to protect the agencies from default. Many agencies issue bonds and the features and risks vary heavily from agency to agency.
Municipal Bonds may be very attractive for certain investors depending of their tax position. However, these bonds come in many shapes and varieties and need to be well understood before investing. Investors seeking to diversify or limit risk may choose to invest in open-ended municipal money market funds or prerefunded municipal bonds. Investors who are seeking more risk may also consider closed-ended municipal bonds funds. Variable rate demand notes, when issued by municipalities, may provide current income without the interest rate risk.
Corporate Bonds may provide greater yields that government bonds but are often the most risky bonds. Convertible bonds are corporate bonds that have equity upside, but ordinarily offer investors lower yields and a subordinated stake in the event of dissolution or bankruptcy. They are fully taxable at the federal, state and local level.