KENTUCKY CROSSWORDS

Consumer Investments

Bond Issuers: Corporations, Municipalities, and the US Government

Corporate Bonds

Companies issue bonds when they need to borrow funds for an extended period of time. Such companies are said to be leveraged, meaning they have debt. Corporate bonds are a common way for companies in the US to raise capital and some corporate bonds are convertible, which means they can be converted into a specified number of common shares of the company's stock at the bondholder's discretion.

Another feature of many publicly traded corporate bonds are protective covenants, which are rules and restrictions on what the management of the corporation may do, as far as financial policy goes. (Remember, management looks out for stockholders first in an average business firm.)

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Most corporate bonds are also callable, allowing the company to buy back a bond issue. If market interest rates fall, companies may want to pay off bondholders and reissue new bonds with a lower coupon rate. Another reason a corporation may exercise the call provision on a bond is in the event that a covenant on the bond restricts them from pursuing activities they believe will profit the business in the long-term, thus benefiting shareholders, (stockholders). Also, a corporation may call in part of its outstanding debt as a means of meeting the obligations of its sinking fund. (A sinking fund is a requirement that the corporation pay off a certain percentage of its debt annually. This can be an advantage for bondholders in that it reduces the risk of default. But lower risk means lower coupon rates upfront.)

The most common publicly traded type of corporate bonds are debentures, long-term bonds that have only the company's creditworthiness as their security. Bonds with some form of collateral pledged to back the bond are known as mortgage bonds. For example, a corporation may issue mortgage bonds to build additional structures. The buildings then can stand as collateral for the bonds used to finance their construction.

An important note to remember when choosing between stocks or bonds from an iffy company: if a corporation declares bankruptcy, bondholders must be paid before stockholders. However, if we are fully informed as to what our money is purchasing, we will not be dealing with "iffy" companies at all.

Municipal Bonds

Municipal bonds, often called "munies" (sometimes spelled "munis") in investor jargon, are those bonds issued by state and local governments, school districts, colleges, and universities, water and sewer districts, and et cetera. Municipal bonds are issued to raise money for various projects, from new roads and parks, to hospitals and libraries.

Some munies are called GOs, or general obligation bonds and others are known as revenue bonds. The difference is that GOs have the full credit and taxing power of a state or local government backing them in as collateral. A revenue bond, on the other hand is backed only by the proceeds, or revenue from the particular project for which the bonds were originally issued to finance -- a highway or hospital or water system, for example. Thus, GOs, or general obligation bonds are usually a safer investment than revenue bonds. Even though municipal bonds also carry some taxability privileges under federal and many state income tax law codes, it is important to remember that municipal bonds are not free of default risk, regardless of the type.

US Government Bonds or Treasuries

Bonds issued by the federal government through the Department of the Treasury are known as government securities and are commonly referred to as "Treasuries" in the investment world. A number of federal agencies also have the authority to issue bonds of their own. One example of an agency bond is type issued by the Government National Mortgage Association,(GNMA), or "Ginnie Mae". These types of bonds, along with Treasuries, are backed by the full and unlimited taxing power of the US federal government. In other words, Treasuries are secured by OUR own salaries and paychecks.

Bonds backed by the US Treasury are considered among the safest of investments. Some have short-term maturities, such as Treasury bills, (or T-bills) and others are long-term, such as Treasury bonds. T-bills are issued in denominations of $10,000 to $1 million and are often sold in lots of $5 million. For the smaller investor the US Treasury offers notes, with original maturities of one to ten years, and bonds with original maturities of ten to twenty years. Note and bond prices are quoted on the market as a percentage of the $1,000 face value, as are T-bill prices. The interest rates and projections for the ten-year Treasury note are often used as benchmarks in the overall bond market and as a reflection of the general condition of the US economy.

Disclaimer: Information on this Web site is intended for consumer informational purposes only.