Types of Taxable Bonds
U.S. Treasury Securities are issued by the United States government and generally are considered the safest of all investments because the timely payments of interest and principal are guaranteed by the U.S. government. Because of the safety advantage, government bonds pay relatively lower interest rates than other fixed income securities. Treasury bonds are issued in a wide range of maturities, from four weeks to 30 years. Generally they are non-callable, and interest payments are exempt from state and local taxes. Treasury bonds can be purchased through your financial advisor or directly from the U.S. Treasury.
Government Agency Bonds are bonds issued by Federal Government Agencies.
Major issuers include:
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Government National Mortgage Association (GNMA), whose securities are backed by the full faith and credit of the U.S. government; subject to market risk
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Tennessee Valley Authority (TVA), whose bonds are not guaranteed by the U.S. government, but are secured by the power revenue generated by the Authority
Government-Sponsored Enterprise securities (GSEs) are issued by government-created corporations and most carry “AAA” ratings.
Major issuers are:
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Fannie Mae (Federal National Mortgage Association)
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Freddie Mac (Federal Home Loan Mortgage Corporation)
Both Fannie Mae and Freddie Mac are government-sponsored entities and operate as public companies. Although both were created by congressional charters, neither is a government agency. Timely payments of interest and principal are sole obligations of the issuers. Their securities do not constitute debt of the United States and are not guaranteed by the federal government.
Brokered certificates of deposit (CDs) are issued by financial institutions, such as banks, and are sold directly through brokerage firms like Raymond James. Brokered CDs have characteristics similar to bonds, but offer the protection of FDIC insurance, which covers up to $250,000 per issuer (including principal and interest) for deposits held in different ownership categories, including single accounts, joint accounts, trust accounts, IRAs, and certain other retirement accounts. FDIC insurance does not protect against principal losses due to sale prior to maturity. Prices of brokered CDs fluctuate during their lifetimes due to changes in interest rates. Upon maturity, CDs are redeemed at par. Consult your financial advisor for more information about the difference between regular bank CDs and brokered CDs. To learn more about brokered certificates of deposit, please read our Disclosure Document (PDF)
Corporate bonds are debt obligations issued by U.S. and foreign companies to raise capital for business growth and general corporate purposes. Most are unsecured promises to repay the principal at a predetermined future date, although some bonds may be secured by a first mortgage or other assets. Since corporate bonds are considered riskier than some other fixed income investments, such as U.S. Treasury bonds, they generally offer higher yields. Corporate bond prices are affected by changes in interest rates, issuers’ credit ratings and other factors. Please consult with your financial advisor about various bond features before investing.
Foreign currency bonds are issued by corporations and governments. In addition to offering bonds in domestic markets and local currencies, governments and companies also can issue bonds in other markets and different currencies. Foreign currency bonds carry additional risks that domestic bonds are not subject to, including currency risk, political instability and local market risk. As with any investment, foreign securities should fit within the investor’s stated objectives and risk tolerance, and should be allocated accordingly.
Preferred securities offer certain benefits of both stocks and bonds. They are most suitable for investors with a long-term time horizon who are interested in a fixed rate of return. Unlike common stocks, most preferred securities are issued with a fixed dividend or interest rate which is typically paid quarterly, and most have a par value of $25 per share. Since most preferred securities are considered debt and are senior to common stock, they enjoy a priority claim over common stock on assets of a corporation in case of a liquidation; however, they are often junior to bond holders. They generally have a much longer term maturity than bonds, and in a number of cases they are perpetual. Some preferred securities are subject to unique risks which include the fact that the issuer may defer interest payments for up to 10 years. However, the investor will be liable for income tax on accrued but unpaid “phantom income.” Further, dividend payments are not guaranteed and will only be paid if interest payments on the underlying obligations are made, which are dependent on the financial condition of the issuer. In addition, most preferred securities are callable at the option of the issuer, just like bonds, and may be subject to tax event or special event calls. The market value is sensitive to changes in interest rates. Unlike common stocks, preferred stocks do not have voting rights.
Mortgage-Backed Securities and Collateralized Mortgage Obligations (MBS) traditionally have been referred to as relatively high quality, high cash flow generating investment vehicles. However, turmoil associated with mortgage loan originations reveals the need to understand these investments and the factors that drive their performance. Many potential investors shy away from MBS, while others consider this an opportune time to invest.
Pass-through securities represent an ownership interest in mortgage loans made by financial institutions (savings and loans, commercial banks or mortgage companies) to finance the borrower’s purchase of a home or other real estate. Pass–through securities are created when these loans are packaged, or “pooled,” by issuers or servicers for sale to investors. As the underlying mortgage loans are paid off by the homeowners, the investors receive payments of interest and principal.
A more complex type of MBS is a collateralized mortgage obligation. CMOs were developed to meet investor demand for more predictable cash flows and specific maturity ranges. These securities can be backed by a pool of mortgages or existing pass-throughs. CMOs are broken down into classes called “tranches.” Monthly mortgage payments received from home owners are directed to different classes according to a principal pay-down priority schedule. To learn about different CMO structures, visit the Securities Industry and Financial Markets Association at investinginbonds.com.
To learn more about these types of securities, contact your financial advisor or use the convenient Office Locator to find our office(s) nearest you.