A bond is a fixed-income security and an IOU given to an investor. When businesses and governmental entities need to raise money they will often issue bonds and sell them to investors. Bonds come with different maturities and interest rates. Investors are paid interest at specified intervals and the original investment is returned when the bond matures.
There are several types of bonds and they each have different characteristics and features.
Treasury bonds were issued by the United States Treasury and are federally insured. They are considered very safe investments and thus have a low return. Interest earn from U.S. Treasury bonds are exempt from local and state taxes, but not from federal income tax. Treasury bonds come in different denominations, ranging anywhere from $1,000 to $1 million. Interest is paid every six months and have maturities up to 30 years. The U.S. Treasury no longer issues treasury bonds, but they can still be purchased on the secondary market and are still backed by the federal government.
Municipal bonds are issued by local governmental entities such as states, cities, counties, townships and utility districts. The proceeds are used to fund schools, roads, and other similar projects. The interest on these bonds are exempt from federal income tax. Sometimes local governments will also make them non-taxable for local residents as well. Municipal bonds are not as safe as U.S. Treasury bonds but offer a fairly high level of security.
Corporate bonds are issued by corporations. Bond issues are generally used to finance corporate acquisitions, new facilities and other large scale corporate needs. There are short term corporate bonds with maturities of less than five years, intermediate term bonds mature in five to twelve years, and long term corporate bonds have maturities exceeding twelve years. Corporate bonds generally have higher yields than governmental bonds because there is more risk involved. Corporate bonds can also include convertible bonds, which allow the bond holder to convert the bonds into stock, and callable bonds which gives the corporation the right to redeem the bond issue before the maturity date.
Another form of bond is the zero coupon bond. They do not pay interest but are instead issued at a discount. A zero coupon bond that has a $1,000 par value and 10 year maturity may sell for $600. At maturity, the bond holder will receive $1,000.
Bonds are attractive to conservative investors due to the fixed income (regular interest payments) and relatively high level of security offered by these assets. U.S. Treasury and Municipal bonds are generally considered to offer more security, but corporate bonds pay higher interest rates.