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Bond Basics
types of bonds
 
 
 
 
Types of Bonds

U.S. Treasuries
Treasury bonds are considered the safest bond issued in the U.S. They are secured by the full faith and credit of the U.S. Treasury. The bonds carry a AAA rating from both Moody’s and Standard & Poors. Due to its size and berth (425 billion trades a day) the treasury market is the most liquid and efficient market in the world.

Treasuries are issued in three defined maturities.
1. Treasury Bills – Mature one year or less
2. Treasury Notes – Mature between two and ten years
3. Treasury Bonds – Mature between 11 and 30 years
The 10 year Treasury serves as a “benchmark” rate from which many other rates in the market are determined (i.e. Mortgage rates, corporate spread rates.)

Individuals, pension funds, insurance companies, commercial banks, money market funds are all examples of the wide variety of investors that give the U.S. Treasury market liquidity. Treasuries may be bought into a brokerage account or may be purchased directly from the government. (www.treasurydirect.gov ) Regular auctions are scheduled. Once an account is set up at Treasury Direct investors may also sell Treasuries in the secondary market through a platform called Sell Direct. All interest earned on Treasuries is subject to both Federal and State taxes.

Federal Agency Bonds
Federal agencies use the debt markets to finance their specific directed activities. Many agencies are authorized to support national programs such as home loans, small business operations, farm credit, Tennessee Valley Authority etc. These agencies are referred to as government-sponsored enterprises (GSE’s).

GES’s credit is considered high. They are funded by appropriation from the Federal government. However, they are not recognized as direct obligations of the government. Agencies trade at a yield premium to treasurers with comparable maturity for this reason. Over three trillion dollars of agencies exist in today’s market. Since they carry a moral support of the US Government, they trade with good liquidity & demand. All interest earned on federal agency bonds are subject to both Federal and State taxes.

Mortgage Securities
Once a mortgage is originated, it can be “pooled” with other mortgages and be securitized into a bond.
The repayment of the underlying mortgages supports the cash flow to investors. Typically, interest on mortgage securities pay on a monthly basis.

The ability to securitize or “pool” vast amounts of mortgages allows for lower cost and greater availability of many to be loaned to individuals and businesses.

The U.S. government has created three agencies whose mandate is to support the smooth introduction of mortgage money into the market. Government National Mortgage Association (GNMA) began guaranteeing mortgages back in 1970. The agency most referred to as “Ginnie Mae”. Ginnie Maes are guaranteed by the U.S. government directly. The other two agencies: Federal National Mortgages Corporation (FHMLC) or “Freddie Mac”; Federal National Mortgage Association (FNMA) or “Fannie Mae”, Are guaranteed by the agencies only. However, since the agencies are guaranteed by congressional funding they are considered government sponsored entities (GSE’s) and are rated second only to direct U.S. Treasuries. Private “non agency” institutions make up the other part of the mortgage market. Private issuers can be a financial institution, homebuilders, or private mortgage companies. The mortgages derived from non-agency underwriters are referred to as “Private Label” securities. Private label mortgages may also be pooled and securitized.

Once pooled, these securities can be broken up into different qualities and cash flow streams. These divisions are referred to as “tranches” This further level of securitization, allows investors to more closely match their individual maturity and risk profiles to the security. Varying risk levels allows for a large scope of access to lenders and provides loans to a wide array of borrowers.

All interest earned on mortgage securties is subject to both Federal and State taxes.

Corporate Bond Market
Capitol needs of US Corporations are ever present. Funding all types of infrastructure and expansion expenses requires corporations to access the debt markets. The corporate bond market provides a large and liquid source of capital. Companies both small and large utilize the trillion-dollar corporate bond market to fund needs ranging from plant and equipment to funding new acquisitions.

The vast range of credits trading on an efficient daily market keep borrowing costs low and liquidity high. An estimated 15 billion dollars of corporate debt trades every day.

Corporate bonds trade on a basis point spread above corresponding treasury yield in the matching maturity. The spread is a function of the quality rating a corporation is assigned by the rating services. For Example: A AAA rated corporate bond that has a maturity corresponding to the 10 year Treasury bond (2.50 %) would generally trade at plus 30 basis points above the treasury (2.80%) An A rated corporate would trade in the range of plus 250 basis points for the same maturity (5.00%) As you can see, credit rating has a considerable impact on the value of a corporate bond. All interest earned on corporate bonds is subject to both Federal and State taxes.

Money Market Securities
On occasion, government, individuals, and businesses need a vehicle to assist with short-term needs. Money market securities fit the bill. They have maturities of one year or less. These short-term securities take the form of commercial paper, tax anticipation notes, certificates of deposit and banker acceptances. The need to fund short-term needs exists for many reasons. It can be to bridge anticipated tax receipts or the collection of a property sale. Money Markets become a beneficial alternative to short-term bank loans because the interest rate is better and the security is still dependable. Since the market is large (over 3 trillion), Liquidity is very efficient. All interest earned on Monely Market Securities is subject to both Federal and State taxes.