How Government Bonds Work & Where to Buy Them
Bonds are a way of loaning money to an organization and getting your money back with interest. A bond is usually issued to reach a set amount of cash to fund a project or keep a company running. It can also be for expansion of an organization. Buying bonds means you are investing a company or government agency with the expectation the money will be repaid at a specific date.
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Bond Issuers
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Bonds are issued by the U.S. government through the Treasury Department and by other government agencies looking to raise money. Other non-federal government agencies issue what are called municipal bonds. These agencies include state, county and local governments. Two other types of bonds issued are corporate and mortgage-backed bonds.
Parts of a Bond
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Bonds consist of three main parts. These are face value, coupon rate and maturity. The face value of the bond tells the value of the bond when it comes due. The coupon rate is the amount of interest paid on the bond each year. The rate is based on current market rate when the bond is purchased. The maturity of the bond is when the face value of the bond is paid back to the purchaser.
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Typical Bonds
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A typical bond will offer a yield that is different from note to note. The factors that can influence the yield of a bond are credit quality, call provision and maturity date.
Credit quality is more like a risk factor. Therefore, the better the credit quality, the less the bond will yield as it is a lower risk on investment. In contrast, the lower the credit quality, the higher the risk for the bond, meaning a higher yield for the purchaser. A call provision in a bond almost always means a higher yield. A longer dated bond will also mean a higher yield.
Callable Bonds
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Bonds are "callable" if the issuer can "call" the bond back in or pay it off at a set price. These bonds usually have higher rates but give the issuer the flexibility to call them back in and reissue the bond at a lower rate if the market dictates. The purchaser does not have any choice but to call the bond in on the date set by the issuer.
Zero-Coupon Bonds
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These bonds are for long-term investment. Zero-coupon bonds will add interest but not pay it until the bond reaches maturity. However, you must include the yearly rates of interest earned on each year's income taxes. The price of these bonds is typically given at extremely discounted rates. These bonds are normally used by parents saving for a child's college education and will cost you a lot if you have to cash them in early.
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