Types of Bonds and Bond Characteristics

Bonds

• Bonds are a type of fixed income or debt investment.
• There are three main types of bonds: corporate bonds, government bonds, and municipal bonds.

Corporate Bonds

• Corporate bonds have a coupon rate, face or par value, and maturity.
• Companies use investment bankers to gauge interest and structure their bond offerings.
• Bond indenture is a written agreement between the corporation and investors, outlining terms of the bond, total amount issued, use of bonds, call positions, and collateral.
• Bearer bonds, also known as "zero coupon bonds," have no registered owner and are no longer used due to theft concerns.
• Seniority in bankruptcy proceedings is: creditors (bondholders), preferred stockholders, and then common stockholders.

Government Bonds

• Government bonds are also known as "treasuries."
• Types of government bonds include treasury bills (short-term, <1 year), treasury notes (medium-term, 1-10 years), and treasury bonds (long-term, 10-30 years).
• Government bonds are debenture bonds, meaning no physical collateral is pledged.

Municipal Bonds

• Municipal bonds are issued by states, cities, and countries and offer a tax advantage (triple tax-free).
• Municipal bonds are also debenture bonds, with no physical collateral pledged.

Bond Trading and Ratings

• All bonds are traded over-the-counter (OTC).
• Bond rating agencies, such as Standard & Poor's, Moody's, and Fitch, rate the creditworthiness of bond issuers.
• Junk bonds have the lowest rating and are high-risk, high-yield investments.

Interest Rates

• Nominal interest rate is the stated interest rate.
• Real interest rate is the nominal rate adjusted for inflation.

Commodities

• Commodities are raw materials used to create products for consumers, including metals, foods, energy, and the S&P 500 (a synthetic commodity index).
• Commodities are traded at mercantile exchanges in Chicago and New York.
• Futures contracts are used for taking physical delivery of commodities.
• The spot market, or cash/physical market, settles in cash.

Options and Derivatives

• Derivatives are securities whose price is dependent on an underlying asset, such as a stock, and are characterized by leverage (speculation).
• Examples of derivatives include options, which can be used for stocks, bonds, currencies, commodities, and market indexes.
• Option contracts give the right to buy (calls) or sell (puts) 100 shares of the underlying stock.
• Calls are bullish (buy) and puts are bearish (sell).
• Options can be used for speculation or as a hedge product to protect another investment.
• The advantage of options is leverage, while the disadvantage is time (they expire).
• Most options expire worthless.
• ESOPS (employee stock option plans) typically have a 5-10 year expiration, must be call options, must be "in the money," and must be sold back to the company.