Question

a. Define four different classes of bonds and detail the characteristics of each. Which class of bonds tends to have the least amount of risk and why?

b. Briefly discuss five financial institutions that historically participate in the bond market. What are the participation goals of each of the institutions?

c. Define the term Bond Yield. Discuss how an investor realizes a return on a bond investment.

Answer 1

Different Classes of Bonds:

There are four primary categories of Bonds there are

• Corporate Bonds are issued by companies it is better than seeking loans from banks. The bond market offers more favorable terms and a low rate of interest.
• Municipal Bonds are issued by states and municipalities some municipal bonds tax-free for investors.
• Government Bonds are those issued by U.S. Treasury. These Bonds are issued by national governments so it referred to as sovereign debt. Bonds are issued by treasury and
  its maturity period is one year or less than one year called Bills, if maturity periods 1 – 10
  years are called notes and if more than 10 years are called bonds.
• Agency Bonds are those issued by government-affiliated organizations.

(II) Characteristics:

• Corporate Bonds are debt issued by a company in order to raise capital. This is a type of bond that is actively traded on the Secondary market and it also seems riskier than U.S government bonds at the same time it also has a higher rate of interest to compensate the additional risk.
• Municipal Bonds are issued by states and municipalities these funds are used for public works such as parks, libraries, bridges & roads, and other infrastructure. Interest paid on Municipal bonds is tax-free and this option attracts the individuals in high tax brackets.
• Government Bonds come with a promise of the full repayment of invested principal at maturity of the security. It also pays periodic coupon or interest payments. These securities may pay a lower rate of interest than corporate bonds.
• Agency Bonds Federal government agency bonds and government-sponsored enterprises provide a high rate of interest than U.S. Treasury bonds and these types of bonds not exempted from state and local taxes.

Among the four bonds Government bonds have low-risk. It will protect investor’s interest payments and maturity payments when interest rates rise. These bonds are more attractive because investors can earn a higher coupon rate at the same holding long period and at the same time it also occurs some risks.

Longer maturity meaning higher interest rate risk and shorter maturity meaning lower interest rate risk.