Agency Bond

finance a la shmoop what are the different types of bonds? okay so yeah

insert the Fifty Shades joke here. bonds the kind that won't get you an r-rating

are serious business actually. your grandparents like lived on them or their

interest anyway and they are the lifeblood of American homes. why because [black and white picture of neighborhood]

another fancy word for a bond is mortgage.

yeah mortgage bonds. yep when you take out a loan to buy a home some mortgage

company aka a bank is creating a bond for you, so you can have that white

picket fence two kids a dog in a room to store all your Star Wars memorabilia. a

bond is a promise. a solemn swear by an individual or an

organization to pay back money loan to them. and the vast majority like well [kids pinkie swear]

over 99% of all bonds made in the US of A pay fully on schedule on time and the

lenders are made whole. despite tons of negative muckraking press we actually

have very few deadbeats in this country. so bonds represent a kind of almost

guaranteed income source for many. they exist as a stabilizing income stream and

with relatively high degrees of safety ie low risk, they understandably carry

less financial reward even generally speaking. and there is a carefully [man goes fishing]

manicured spectrum of risk in bonds. all right let's start with government bonds.

the lowest risk lowest financial return but safest bonds are US government bonds,

which are backed by the country's ability to tax its hard-working citizens.

government bonds and well-funded corporations carry what is called a

A rated paper or A ratings. Yes even governments get credit ratings. [chart showing ratings]

gets riskier the ratings of that bond get lower and lower all the way down to

a category called junk. which are bonds where the interest covering them has

material "iffiness". technical term. Puerto Rico a u.s. territory famously defaulted

on its bonds in 2017 so its credit rating lives [man stands in front of city]

out here. so yeah government bonds are the safest bonds and usually also pay

the lowest interest rate. corporate bonds alright well next on the food chain are

corporate bonds companies put cash in their bank accounts in three basic ways,

they sell equity or ownership or shares or stock in themselves like in an IPO.

they can also make money from selling their product that is a single shingle

sells for 19.95 and they keep $4 in 82 cents and profits from it times 10 [birds on a roof]

million and you know that's a lot of cash from shingles. and C they put cash

in their coffers by selling bonds or selling debt. that is they pay rent for

borrowing the cash money just as government's do. what do Microsoft Koch

and your deadbeat uncle all have in common well they all have debt

outstanding. most companies like well over 99% of them boringly pay off all [long haired man frowns from the couch]

their interest and when the bonds come due however many years or decades later

they pay the principal and they're done. they presumably use the money wisely but

the more interesting Bond stories revolve around the times when company's

best laid plans go awry and they snuggle up real close next to bankruptcy. if our

roofing company we've got shingles has ninety million bucks in pre-tax profits

they might have one point six billion dollars of bonds with an interest rate

of 5% well the interest costs are 80 million dollars a year so the company is [equations]

only making 10 million bucks. just enough to cover the interest should the profits

fall well the company would go into default, they'd miss an interest payment

and then in theory the bondholders could a well, just repossess the company.

the bondholders would control the company sell off assets to pay

themselves back their loans, and well then the company usually dies. so that's [man carries buckets of shingles]

not good and that's why the bonds are called junk, or in more proper parlance

high-yield. they live way to the right on the risk spectrum because that whole

snuggling up right next to bankruptcy thing is not something Wall Street

people like doing .childhood intimacy issues I guess. so while a very safe US

government 10-year bond might pay 3% interest a similar but very junky junk

junk junk corporate bond my pay 12% or more to adjust for the very

high degree of risk. there are other flavors of funds as well, one highly [corporate bond pictured]

popular bond with high tax payers are muni bonds. 8k a municipal bonds yep.

they're a special class a bond generally created so that local areas can fund

projects important to their community. like parks and parking structures and

sports arenas. they're structured just like corporate and government bonds and

that they have principal, the amount being borrowed, and a rental rate or

interest rate for renting the money. the one key difference no tax yeah. say that

again. sweet sweet music. no tax .whereas government corporate bonds are taxable

Muniz generally are not. well why the big break because the feds wanted local [chart]

people to really care about the local financial health of whatever

infrastructure they were building locally. so the federal government

doesn't have to get its hands dirty in city activities, whether that's building

a new field for the local baseball team or supporting a local park that's been [man folds arms in front of construction site]

down and out because the roofing company who built the little shack that housed

all the toys in it caved in. so as you can see there are more varieties of

bonds than there are flavors in an ice-cream shop, even if none of them hit

the spot quite like rocky road. now that'll give you long term gains. [man smiles in an ice cream shop]