Bonds are debt securities issued by governments, corporations, and other entities. In return for the loan of money to the issuer represented by the bond, the issuer promises to pay a set rate of interest over the life of the bond and then pay back the principal or face value of the bond to the investor when the bond matures or becomes due.
There is a secondary market for bonds prior to their maturity in which the value of the bonds varies according to interest rates and expectations concerning the ability of the issuer of the bond to return the face amount of the bond when it matures. The value of the bond also is affected by the fact that an investor who sells a bond before its maturity may have to pay either a commission on the sale or a broker “markdown” of some percentage of the sales price to cover the cost of the transaction.
Prevailing interest rates also affect the price at which a bond may be sold in the secondary market. If interest rates fall between the time of purchase of the bond and the investor’s pre-redemption sale of the bond, the investor will receive a premium above the par or face value of the bond. On the other hand, if interest rates rise, the pre-redemption sales price of the bond will fall.
Types of bonds include United States government securities, municipal and state securities, corporate bonds, mortgage and other asset-backed securities or bonds, federal agency securities, and bonds issued by foreign governments and other entities.
U.S. government securities include:
- Treasury bonds (last issued in October 2001 in maturities up to 30 years);
- I-bonds pegged to inflation rates;
- EE bonds with variable market-based interest rates; and
- Marketable securities categorized as:
- Treasury bills (also known at T-bills and issued for 13 or 26 weeks);
- Treasury notes (also known at T-notes and issued for terms of 2, 3, 5, and 10 years at rates set through auction); and
- Treasury Inflation-Protected Securities (TIPS) with a set rate of interest with the principal adjusted semi-annually for inflation.
The category of municipal bonds covers debt securities issued by government entities other than the U.S. government and includes bonds issued by states, counties, cities, municipalities and multi-jurisdictional agencies. Such securities are issued to raise funding for public projects such as school construction, road building, and infrastructure building and maintenance. Interest received on such debt securities is exempt from federal taxation. Municipal bonds normally are issued for relatively long terms during which interest payments are made by the governmental entity, usually semi-annually, to investors and at the end of which the principal amount of the bonds is returned to the investor. There is a secondary market in such bonds.
The Securities and Exchange Commission regulates the bond markets. However, interest payments on bonds are subject to supervision by state and federal banking authorities rather than the Securities and Exchange Commission.