Types of Bonds
Basic Terms of Corporate Bonds
One of the key investment features of any bond is its maturity. A bond’s maturity tells you when you should expect to get your principal back and how long you can expect to receive interest payments. (However, some corporates have “call,” or redemption, features that can affect the date when your principal is returned.)
Corporate bonds, in general, are divided into three groups:
- Short-term notes --Maturities of up to 5 years
- Medium-term notes/bonds --Maturities of 5-12 years
- Long-term bonds -- Maturities greater than 12 years
Investors may also encounter the term “commercial paper”, which is the market where companies issue short term (maturing in 270 days or less) fixed income bonds. Commercial paper does not have a coupon; it is issued at a discount and repaid at par. As commercial paper is not secured debt, holders have the risk of default; therefore only companies with high credit ratings can issue commercial paper.
Another important fact to know about a bond is its structure. With traditional debt securities, the investor lends the issuer a specified amount of money for a specified time. In exchange, the investor receives fixed payments of interest on a regular schedule for the life of the bonds, with the full principal returned at maturity. In recent years, however, the standard, fixed interest rate bond has been joined by other varieties of bonds. The three types of bonds you are most likely to be offered are these:
- Fixed-rate or straight or conventional bonds--Most bonds are still the traditional fixed-rate securities described above.
- Floating-rate—Floating rate bond notes (FRNs) (sometimes called “floaters”) are bonds with coupons that are variable interest rates that are adjusted periodically based on a reference rate, usually LIBOR (London Interbank Offer Rate) or EURIBOR (Euro Interbank Offer Rate) rates plus or minus a fixed number of basis points (in a similar way to variable rate mortgages which adjust periodically usually based on the central bank rate or the lenders base rate). While such bonds offer protection against increases in interest rates by adjusting to changes in the marketplace interest rates, their yields are typically lower than those of fixed-rate securities with the same maturity.
- Convertible bonds --are straight corporate bonds that usually have a relatively low coupon combined with an option of allowing the bondholder at a time in the future to exchange the bond for shares, the number and price of which is fixed.
Corporate bond interest, also known as the “coupon”, is usually paid semi-annually. Zero-coupon bonds pay no periodic interest; zero-coupon bonds are sold at a significant discount from their eventual value or return at redemption.