A bond is a loan an investor makes to an organization in exchange for regular interest payments over a specific period of time. At the end of that period, known as its maturity date, the loan is repaid in full. A key differentiator as to whether a bond investment is safe or risky depends on to whom the loan is made.
Treasuries are considered the safest bonds available because they are backed by the “full faith and credit” of the U.S. government. They are quite liquid because certain primary dealers are required to buy Treasuries in large quantities when they are initially sold and then trade them on the secondary market. Treasuries also are more affordable than other types of bonds; you can buy one for as little as $100. Investors can purchase Treasuries through brokerage firms, banks or the Treasury Direct website.
A treasury bond with a maturity of one year or less is called a Treasury bill, or T-bill. A maturity between two and 10 years is a Treasury note, or T-note. The term Treasury bond generally refers to long-term maturities of 10 to 30 years from their issue date.
Other types of government bonds include those issued or guaranteed by U.S. federal government agencies and those issued by government-sponsored enterprises, which are corporations created by Congress for public use. GSEs include the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage (Freddie Mac) and the Federal Agricultural Mortgage Corp. (Farmer Mac). Agency bonds are backed by the U.S. government, but GSE bonds do not enjoy quite the same guarantee and therefore pose greater credit risk.
Next on the bond risk spectrum are municipal bonds (muni bonds), which are issued and guaranteed by individual states, cities, counties and other government entities. These bonds use loan funds to build roads, schools and other public projects. The guarantee for muni bonds is made by the issuer, so while they are relatively secure because they come from government issuers, their level of risk varies depending on the financial stability of the backing agency.
Next on the risk spectrum are corporate bonds, which are issued by all types of companies in order to raise money for capital expenditures, operations and acquisitions. They work just like government bonds and, should the issuer claim bankruptcy before the principal is repaid, bondholders are positioned toward the front of the line for at least a partial repayment. Corporate bonds are generally categorized as either investment grade or non-investment grade, which refers to how risky they are. Investment grade bonds are generally lower risk, but non-investment grade bonds – also referred to as high yield or junk bonds – tend to pay out higher interest to compensate for that risk.
While global diversification can be a good risk mitigation strategy for some investors, international bonds are considered more risky than domestic bonds, and emerging markets bonds are considered the most risky. Because these bonds are issued by foreign governments and companies, the risk varies by issuer and is impacted by political, cultural, environmental and economic factors. Furthermore, foreign bonds expose investors to currency risk, which means the value of payments can fluctuate once funds are converted to U.S. dollars.
FAQs
Treasuries are considered the safest bonds available because they are backed by the “full faith and credit” of the U.S. government. They are quite liquid because certain primary dealers are required to buy Treasuries in large quantities when they are initially sold and then trade them on the secondary market.
Which type of bond is the safest? ›
Savings Bonds
These are the safest investment since they're backed by the government and guaranteed not to lose principal. They don't offer exceptional yields, but that isn't the point. If you want to keep your money safe, savings bonds are the best option.
Which are safer corporate or government bonds? ›
If the issuer goes out of business, the investor may never get the promised interest payments or even get their principal back. Corporate bonds are generally considered riskier than government bonds because governments have the option of raising taxes to meet their obligations.
Which bond is more secure? ›
Senior secured is the most senior debt of any company and senior secured bondholders get paid first. Hence, it is considered to be the safest debt of any company.
Are agency bonds safer than municipal bonds? ›
1. risk tolerance: Consider your risk tolerance. Municipal bonds are generally perceived as lower risk due to their tax advantages and backing by municipalities, while agency bonds provide a middle-ground risk profile. If you prioritize safety, municipal bonds might be more suitable.
What type of bonds have the least risk? ›
GOVERNMENT BONDS
Intermediate-term bonds mature in three to 10 years, whereas long-term bonds generally mature in 10 to 30 years. Risk Considerations: Among the lowest risk of all bond investments, these bonds have low credit risk because they are backed by the full faith and credit of the U.S. government.
Which type of bond is the safest Quizlet? ›
Bonds issued by the US government are considered to be the safest of all financial assets because they have almost no risk of ever being in default.
Are CDs safer than Treasuries? ›
CDs and Treasurys are both safe, relatively riskless investments. Since CDs are considered deposit accounts, they're covered by Federal Deposit Insurance Corp. (FDIC) insurance, up to $250,000 per depositor, per bank. You can check if a bank is FDIC-insured on the BankFind Suite website.
Is it better to buy Treasuries or CDs? ›
Choosing between a CD and Treasuries depends on how long of a term you want. For terms of one to six months, as well as 10 years, rates are close enough that Treasuries are the better pick. For terms of one to five years, CDs are currently paying more, and it's a large enough difference to give them the edge.
Can corporate bonds lose value? ›
What causes bond prices to fall? Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
If you're holding the bond to maturity, the fluctuations won't matter—your interest payments and face value won't change. But if you buy and sell bonds, you'll need to keep in mind that the price you'll pay or receive is no longer the face value of the bond.
Is there a better investment than bonds? ›
Preferred stock resembles bonds even more and is considered a fixed-income investment that's generally riskier than bonds but less risky than common stock. Preferred stocks pay out dividends that are often higher than both the dividends from common stock and the interest payments from bonds.
Which bond is best to invest in? ›
Best Corporate Bond Funds to invest in February 2024:
- HDFC Corporate Bond Fund.
- Aditya Birla Sun Life Corporate Bond Fund.
- ICICI Prudential Corporate Bond Fund.
- Sundaram Corporate Bond Fund.
Agency bonds are securities issued by U.S. government agencies or Government-Sponsored Entities (GSEs). Agency bonds are considered low-risk, although not as safe as U.S. Treasurys. Agency bonds can be callable and paid off by the borrower before they mature.
What are the downsides of agency bonds? ›
All agency bonds carry the credit risk that the issuer will default or will be unable to make timely payments of interest and principal.
What is the downside of municipal bonds? ›
Municipal bonds, like all bonds, pose interest rate risk. The longer the term of the bond, the greater the risk. If interest rates rise during the term of your bond, you're losing out on a better rate. This will also cause the bond you are holding to decline in value.
What is the most risk-free bond? ›
U.S. Treasury bonds (T-bonds) are often touted as risk-free investments. And it's true. You would have to envision the utter collapse of the government and society to find a scenario that would involve losing any of the principal invested in a T-bond.
What bonds don't lose value? ›
A stable value fund is a portfolio of bonds that are insured to protect the investor against a decline in yield or a loss of capital. The owner of a stable value fund will continue to receive the agreed-upon interest payments regardless of the state of the economy.
