Too often investors are surprised by the potential opportunities of fixed-income investments. This can often be attributed to a lack of familiarity with the many different terms used to describe fixed-income offerings.
Bonds can vary in yield, safety, maturity, frequency of interest payments, denominations, risk and tax treatment. When buying and selling fixed-income investments, you will encounter some of the following terms that help describe them, so be prepared.
Bond: A debt obligation, or loan, that can be bought or sold as a security by governments and corporations. Most bonds offer regular pay outs, or dividends, based on a set interest rate. The bond’s purchase price is returned to the investor at maturity (the date when the term of the loan ends.)
Bills: Treasury bills or T-bills are not to be confused with Treasury bonds or notes. They are short-term (up to one year) loans that do not pay out regular interest, but are sold at a discount to their redemption price. Actively traded, these bills offer relatively easy liquidity and often determine the market’s short-term rates. For medium terms of one to 10 years, investors may purchase Treasury notes, which do offer you semiannual interest payments.
Calls: Many bonds are sold with the option for the issuer to pay off its creditors (you) early. These call options are pre-established, along with possible dates, risks and premiums that they will pay for early redemption.
Coupon: The coupon rate is the interest rate that an issuer is obligated to pay the bondholder until it matures. The term comes from the days when bondholders were given a set of coupons to send in for their payments.
Zero-coupon bonds are sold at a discount and redeemed at face value. They do not offer any interest payments along the way, although implied interest accrues and is taxable each year.
Corporate Bond: A debt obligation that a corporation issues. While yields tend to be high, so do the risks, when compared to government-backed securities. Corporate bonds are not tax-exempt, and selecting them requires the same level of research as picking stocks.
Federal Agency Securities: “Agencies” are issued by federally owned and guaranteed organizations (the Export-Import Bank) or agencies that have spun off from the government (the Federal Home Loan Banks.)
Government Bonds: This includes Treasury bonds, U.S. Savings Bonds and bonds that federal agencies (such as Ginnie Mae) issue. They are considered the safest among bond investments because the U.S. government backs them. Many are exempt from state and local taxes.
Maturity: The term or length of a debt obligation. Maturities typically range from one to 30 years. T-bills offer shorter maturities of three, six and 12 months.
Municipal Bond: State and local governments issues “munis,” which are usually exempt from federal taxes, as well as taxes for residents of the state or city from which they are issued.
Par: The price at which a bond is issued and will be redeemed at maturity.
Ratings: Bonds are rated by agencies such as Moody’s Standard & Poor’s to help investors understand the risk level associated with each issue. Investment-grade bonds are given a rating of triple-B to triple-A. Bonds rated below triple-B are considered more speculative.
Spread: In essence, the profit made from buying and selling a bond. It represents the difference between the price bid (or offered) to buy a bond and the asking price to re-sell it.
Understanding and exploring these terms can help you learn the basics of fixed-income investing. Contact your financial advisor for details on how these vehicles may add value to your portfolio.
This column is produced by Financial Planning Associates, and is provided by R.Hutton Cobb, a Wachovia Securities financial advisor in Greenville, N.C.