Bonds are debt securities that enable entities, such as corporations or governments, to borrow money from investors for a specified period, offering a fixed interest in return. They serve as a fundamental tool for raising capital, providing investors with a predictable income stream and the return of the principal upon maturity.
This article delves into 7 types of bonds that investors can consider to trade:
- Government bonds
- Treasury bonds
- Sovereign bonds
- Municipal bonds
- Corporate bonds
- Mortgage bonds
- Convertible bonds
If you’re unfamiliar with bonds, you can read this article that covers what bond trading is.
Governments worldwide issue bonds as debt securities to help raise funds for financing their budgetary needs, whether it’s for infrastructure development, public welfare programs, or debt management.
In return for this loan, the government promises to pay bondholders periodic interest payments, often referred to as coupon payments. These payment frequencies can vary depending on the bond’s terms but are usually made semi-annually.
These bonds are typically considered low-risk since they are backed by the full faith and credit of the issuing government. At the end of the bond’s term or maturity date, the bondholder will receive its principal value. Due to their secure nature, government bonds often have lower yields (2%) compared to corporate bonds . However, they are also favoured by conservative investors for their stability and predictability.
The US Department of the Treasury issues various debt instruments to finance the government’s expenditures. Among these, Treasury bonds (T-bonds) are the most widely known.
They come in three categories based on their maturity periods :
- T-Bill: Maturity period of 1 year or less
- T-Note: Maturity period of 2 to 10 years
- T-Bond: Maturity period of 10 to 30 years (or longer)
Treasury bonds are pivotal in helping the US government fund various endeavours, from infrastructure projects to social welfare programs and national debt management. During economic uncertainties and volatile markets, many traders seek refuge in T-bonds’ reliability and safety.
It’s worth noting that T-bills operate differently from T-notes and T-bonds. While the latter two offer periodic interest to holders, T-bills are unique. T-bills are sold at a price lower than their face value, and upon maturity, they’re redeemed for their full-face value. This difference between the purchase price and the face value serves as the investor’s potential return.
Treasury bonds pay a fixed rate of interest, which can generate steady returns. Additionally, these bonds are low risk, as they are backed by the US government, which has a lower default risk.
Sovereign bonds are debt instruments issued by a national government to secure funds for various purposes, including financing government initiatives, settling previous debts, and covering other fiscal requirements. These bonds can either be denominated in the government’s currency or a foreign currency, and they represent an agreement by the government to pay periodic interest and return the principal on a specified date.
Developed nations with stable economies often have their bonds classified as virtually risk-free. In contrast, emerging markets might offer higher yields to compensate for increased risks. For example, the JPMorgan Emerging Market Bond Index Global (EMBIG), a common benchmark for emerging market hard currency sovereign bonds, is 8.7% which is significantly higher than the yield of the 10-year US Treasury bond, which is currently around 4.37% as of 19 September 2023 [3,4].
Before purchasing sovereign bonds, traders should be aware of their bond rating. This rating reflects the issuer’s financial health and capacity to fulfil the bond’s principal and interest obligations.
Municipal Bonds are issued by local governments, such as cities or state governments. The funds raised are often used for public projects like road infrastructure, new schools, or hospitals, which ultimately contribute to community development and enhancing the quality of life for residents.
One advantage of municipal bonds is their potential tax benefits. In many places, the interest from these bonds is exempt from government taxation. For investors, this can lead to better returns on their investment, making municipal bonds an appealing choice for trading.
Corporate bonds are issued by companies to raise capital. They are used for company expansion, undertaking new projects, and serving as a form of debt financing . An investor who buys these bonds is essentially loaning money to the company in return for periodic interest payments and the bond’s face value upon maturity.
These bonds often offer higher yields than government bonds but come with greater risk. This higher risk arises because corporations are relatively more likely to default on their debt compared to governments.
The bond’s rating, provided by agencies like Moody’s or Standard & Poor’s, plays a vital role in helping investors gauge the default risk and make informed decisions. For those looking to minimise the risk of default, it’s advisable to select bonds that have AAA or AA ratings. However, it’s important to note that bonds offering higher yields are more likely to come with a higher risk or a poorer rating.
Mortgage bonds are a type of asset-backed security that represents claims to a specified mortgage pool’s cash flow. These bonds are secured by real estate properties, specifically mortgages. When people take out mortgages from lending institutions, these mortgages can be bundled together and sold as investments to the broader market in the form of these bonds.
The primary appeal of mortgage bonds lies in their dual layer of protection. Firstly, the bond is backed by the actual real estate property; should the borrower default, the property can be seized and sold to recover the funds. Secondly, they are protected by a pool of mortgages. This means if one mortgage in the pool defaults, the others can still generate cash flow.
However, potential investors should note the risks associated with fluctuations in interest rates. As interest rates fluctuate, the rate of mortgage refinancing can also vary. High rates of refinancing can lead to early bond repayments, potentially affecting the returns.
Convertible bonds are a hybrid financial instrument, combining elements of debt and equity. These bonds give the holder the right, but not the obligation, to convert the bond into a predetermined number of shares of the issuing company at specific times during its life. The conversion rate and other terms are defined at issuance and are often determined in the bond indenture.
For investors, the appeal of convertible bonds lies in their potential and flexibility.
If the company’s stock price rises significantly, the bondholder can choose to convert their bonds into shares to potentially make a return from the stock price appreciation. Conversely, if the stock underperforms, investors can still receive the bond’s regular interest payments and the return of principal at maturity without converting into stocks.
Vantage Bond CFDs
Now that you’ve discovered the different types of bonds, why not open a live account today with Vantage and engage in bond trading via Contracts for Differences (CFDs)? With Vantage, you can trade a wide array of bond CFDs, potentially capitalising on both rising and falling market opportunities.
The bonds available on Vantage include:
- US 10 YR T-Note Futures Decimalised (TY)
- UK Long Gilt Futures (FLG)
- Euro – Bund Futures (FGBL)
Open a live account and start trading today!
- “How Do Corporate Bonds Differ From Government Bonds? – Forbes”. https://www.forbes.com/sites/investor-hub/article/how-do-corporate-bonds-differ-from-government-bonds/?sh=3d6a8e5930b7. Accessed 20 Sep 2023.
- “Government Bond: What It Is, Types, Pros and Cons – Investopedia”. https://www.investopedia.com/terms/g/government-bond.asp. Accessed 10 Aug 2023.
- “Time to consider emerging-market fixed-income? – Allianz Global Investor”. https://www.allianzgi.com/en/insights/outlook-and-commentary/time-to-consider-emerging-market-fixed-income. Accessed 20 Sep 2023.
- “10 Year Treasury Rate (I:10YTCMR) – Y Charts”. https://ycharts.com/indicators/10_year_treasury_rate. Accessed 20 Sep 2023.
- “Corporate Bond: Definition and How They’re Bought and Sold – Investopedia”. https://www.investopedia.com/terms/c/corporatebond.asp. Accessed 10 Aug 2023.