Types of Bonds
Types of bonds
- Zero-coupon bond. A bond where the interest is not paid out (hence the name "zero coupon") during the life of the bond. Instead, the interest accrues (builds up) and is paid along with the principle at maturity.
- Perpetuity. A bond with no maturity. This means they pay interest forever. These aren't too common in the real world (although the British Government has some perpetuities that still trade today). Perpetuities are useful theoretical concepts because they basically represent an infinite cash flow stream. So the method of valuation could also be used to value real estate, which is also assumed to have an infinite cash flow stream.
- Callable bonds. A bond where the issuer has the right to buy back (i.e. "call in") the bond from you. Callable bonds will usually offer a higher yield to compensate a bondholder for the possibility of having the bond be bought back.
- Convertible bonds. A bond where the holder of the bond has the right to convert the bond into stock if certain conditions are met.
- Junk bonds. Bonds that carry a high risk of default. These bonds offer a high yield in order to compensate investors for that risk. They are considered speculative because they are below "investment grade". Whether a bond is technically classified as a junk bond will depend on it's rating it receives from the major bond rating agencies (like Standard & Poor's).
- Asset-backed bonds. These are bonds that are backed up by specific assets such as mortgages or credit card or student loan debt.
- Savings bonds. Savings bonds are treasury securities issued by the U.S. government for individual investors. There is no market (i.e. secondary market) for savings bonds so you can't buy and sell them but they can be redeemed with the Treasury after holding them for one year. Savings bonds do not have coupons. The interest on the bonds accrues and is paid out only when the bond is redeemed.
- Inflation-indexed bonds. These are bonds whose principal are indexed to inflation. The U.S. Government issued inflation-indexed bonds call "Treasury Inflation-Protected Securities", or TIPS for short, in 1997.
- Bearer bonds. A bond where the physical holder of the bond is entitled to the interest payments. There is no record of ownership of the bond. Therefore is you lose it you don't get any interest or principle. These bonds are issued to provide the bond buyer anonymity. Because there is no record of the bondholder there is therefore no record of interest income received from the bond, which would make it much easier to receive income without paying taxes (although this is still 100% illegal).