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Home Finance Investing Types of Bonds

Types of Bonds

There may only be one 007 but the bonds in your investment portfolio are a dime a dozen.

Or at least like a couple thousand bucks a dozen.

Senior Obligation Bonds

Just like the seniors at your school call first dibs on everything, senior debt on a corporate balance sheet comes with some privileges: it's the debt that gets paid first. If a company files for bankruptcy and closes, senior obligation bonds or senior bonds are paid first, which means there's a chance you could still end up getting your money back.

Junior Obligation Bonds

Just as it says on the tin: these ones are in line behind senior obligation bonds. In case of a bankruptcy, these bonds are paid after the senior ones are paid…if there's still money left.

Asset-Backed Bonds

Bonds can be backed by specific assets of a company. For example, a tech company may back its bonds by a specific line of gadgets, or you might back the bonds in your babysitting business with your laptop.

The big advantage here is that you can get more comfortable with risk. If you buy an asset backed bond from an airline company and that bond is backed by the equipment they lease themselves, you can take a quick peek at how much that equipment is worth to assure yourself you'll get your money back if the company tanks.

Debenture Bonds

Dentures are the fake teeth you might be using by the time you cash in your bonds. Debentures, on the other hand, are a type of bond.

Unlike asset-backed bonds, debentures are not backed by assets. With these guys, you only have the credit and faith of the company that you will get paid back.

Why would you want to take the risk? Well, because the risk of a company not repaying bonds back is very low to begin with. A company's finances would have to go through the equivalent of a zombie apocalypse not to pay back the bonds, so these bonds are not much less safe than most others.

There's also a nice perk with debentures: they're usually convertible. No top-down rides involved—it just means you can convert your bonds into shares of stock at the same company in some situations. If share prices increase, that can be a nice feature that lets you invest your money in a different way.

Zero-Coupon Bonds

Sometimes called zero payment bonds, these puppies don't pay cash interest over time. Instead, you get paid the total amount of interest and the principal of the bond (that's the money you paid upfront) once the bond comes due. So you get one lump payment rather than interest payments each month or each year.

Thanks to compound interest, you can enjoy a tidy sum with zero coupon bonds. If you slapped down $1,000 for a bond that carried a 12% rate of interest, you'd get over $2,000 with compounding after seven years…and you'd get it in one nice windfall.

These bonds are seen as more risky because a company might be scrambling to pay off all those lump sums of money when the bonds come due, just like you might be scrambling to turn everything in if five of your teachers ask for essays on the same day. To make investors happier, some companies create a sinking fund, which is their version of a piggy bank. Companies put money into this fund so that they have the cash to pay you when you bond comes due.

Government Bonds

If you ever read the news, you know that the government isn't necessarily better at managing its debt than you are at managing yours. This country hums along on debt and the government borrows money for roads, the military, education, and other government projects. To pay for all that, the government taxes you.

But they also issue bonds.

Government bonds include bonds issued by the feds (these include T-bonds, which take a long time to mature) and bonds issued by state and local governments (these are called municipal bonds).

These investments are considered very secure because the government can always turn around and tax people to get the money to pay you. Government bonds also come with some nice tax advantages.

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