ShmoopTube

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

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

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

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

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another fancy word for a bond is mortgage.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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the bondholders would control the company sell off assets to pay

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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people to really care about the local financial health of whatever

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infrastructure they were building locally. so the federal government

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

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

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

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

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

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

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