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There are several different types of bonds and bond issuers.  Bonds can have fixed rates, variable rates and may be pre-paid by the bond issuer at any time.  Some bonds even have fixed rates for a portion of their term and variable rates for another portion of the term.  The particulars of how a bond functions are found in the bond's prospectus. 

When you buy a bond issued in US dollars, you are assuming two different types of risk. You are assuming the credit risk that the bond issuer may not be able to repay you at the bond's maturity date.  You are also assuming the risk that you will tie up your money in a bond that may eventually pay you less than market rates.  The further out the maturity date of the bond, the more risk you are assuming since your money is tied up for a longer period of time and is subject to more interest rate movements in the market.  Of course if rates go down, you are sitting pretty.   

Bonds purchased from a foreign country introduce a third risk, the risk associated with changes in the currency exchange rate between the US and the country of the bond issuer.

The credit risk associated with bonds range from relatively safe Treasury bills to extremely risky junk bonds to corporations or countries that are in a questionable financial position.  The greater the perceived risk associated with a bond issuer, the higher the interest rate you will be paid.  When selecting the type of bond to purchase, you should try to match your tolerance for risk with the characteristics of the bond..

Some of the bonds available include:

  1. U.S. Treasuries. These bonds are backed by the federal government and are exempt from state and local taxes. There are several types of Treasuries:

    • Treasury bills are a short term investment. They mature in 13 weeks, 26 weeks, or one year. T-bills cost at least $10,000.

    • Treasury notes mature in two to ten years and pay interest twice a year. The minimum investment is between $1000 and $5000.

    • Treasury bonds mature in 10 to 30 years and pay interest semiannually. You can buy a Treasury bond for $1000.

    • Zero-coupon Treasuries. These pay no interest until they mature. You can purchase a zero for $5000 at a large discount from face value. They mature anywhere from 6 months to 10 years.

  1. Corporate bonds. Unlike Treasuries, earnings on corporate bonds are fully taxable. Since these are issued by individual companies, their reliability depends on the issuing company. The safest are investment-grade bonds and the riskiest are junk bonds, or high-yield issues.

  1. Municipal bonds. Also called munis, these bonds are issued by state and local governments. They usually cost $5000 and over and are free from federal taxes. If you live in the area that issues the muni bond, you do not have to pay local or state taxes either.

  1. Mortgage-backed bonds. These bonds represent ownership of mortgage loans issued or backed by government agencies and are not tax exempt. Mortgage-backed bonds do not gain much value when interest rates go down since homeowners often decide to refinance and get loans at a lower rate, resulting in some of the bond being repaid. They usually cost at least $25,000.

  2. Foreign bonds. Foreign bonds are very sensitive to changes in the exchange rate. If the value of the dollar goes up, your bond also increases in value. They help diversify your bond portfolio because interest rates in other countries do not match those of the U.S.