Types of Taxable Bonds
U.S. Treasury Securities are issued by the United States government and are generally considered the safest of all investments. Because of the safety advantage, government bonds pay relatively lower interest rates than other fixed income securities. Treasury bonds are issued in a wide range of maturities, from four weeks to 30 years. Generally, they are non-callable and the interest payments are exempt from state and local taxes. The timely payments of interest and principal are guaranteed by the U.S. government. Treasury bonds can be purchased through your financial advisor or directly from the U.S. Treasury.
S&P Downgrade of United States’ Long-Term Credit Rating
On August 5, 2011, Standard & Poor’s announced that it has lowered its long-term sovereign credit rating on the United States of America to ‘AA+’ from ‘AAA’ and affirmed the ‘A-1+’ short-term rating. The outlook on the long-term rating is negative. Standard & Poor’s also removed the short- and long-term ratings from CreditWatch negative. On August 2, 2011, the U.S. government’s ‘Aaa’ bond rating was confirmed by Moody’s with a negative outlook. More about ratings is available at standardandpoors.com, moodys.com and fitchratings.com.
On August 8, 2011, as expected, S&P also lowered ratings on related issues, including Fannie Mae and Freddie Mac.
Government Agency Bonds are bonds issued by Federal Government Agencies.
Major issuers include:
- Government National Mortgage Association (GNMA), whose securities are backed by the full faith and credit of the U.S. government; subject to market risk
- Tennessee Valley Authority (TVA), whose bonds are not guaranteed by the U.S. government, but are secured by the power revenue generated by the Authority
Government-sponsored Enterprise securities (GSEs) are issued by government-created corporations and most carry “AAA” or “AA” ratings.
Major issuers are:
- Fannie Mae (Federal National Mortgage Association)
- Freddie Mac (Federal Home Loan Mortgage Corporation)
- Ginnie Mae (Government National Mortgage Association), – whose securities are backed by the full faith and credit of the U.S. government; subject to market risk
Both Fannie Mae and Freddie Mac are government-sponsored entities and operate as public companies. Although both were created by congressional charters, neither is a government agency. Timely payments of interest and principal are sole obligations of the issuers. Their securities do not constitute debt of the United States and are not guaranteed by the federal government. Fannie Mae and Freddie Mac are presently under the Federal Housing Finance Agency’s conservatorship. During the conservatorship, both enterprises will continue normal business operations, including interest and principal payments. For more information, please visit fhfa.gov.
Brokered certificates of deposit (CDs) are issued by financial institutions, such as banks, and are sold directly through brokerage firms like Raymond James. Brokered CDs have characteristics similar to bonds, but offer the protection of FDIC. FDIC insurance covers up to $250,000 (including principal and interest) for deposits held in different ownership categories, including single accounts, joint accounts, trust accounts, IRAs, and certain other retirement accounts, per issuer. FDIC insurance does not protect against principal losses due to sale prior to maturity. Prices of brokered CDs fluctuate during their lifetimes due to general changes in interest rates. Upon maturity, CDs will be redeemed at par. Consult your financial advisor for more information about the difference between regular bank CDs and brokered CDs. To learn more about brokered certificates of deposit, please read our Disclosure Document (PDF).
Corporate bonds are debt obligations issued by U.S. and foreign companies to raise capital for business growth and general corporate purporses. Most are unsecured promises to repay the principal at a predetermined future date, although some bonds may be secured by a first mortgage or other assets. Since corporate bonds are considered riskier than other fixed income investments, such as U.S. Treasury bonds, they generally offer higher yields. Corporate bond prices are affected by changes in interest rates, issuers’ credit ratings and other factors. Please consult with your financial advisor about various bond features before investing.
Foreign currency bonds are issued by corporations and governments who are looking to expand their markets of issuance. In addition to offering bonds in domestic markets and local currencies, governments and companies can also issue bonds in other markets and different currencies. Foreign currency bonds carry additional risks to which domestic bonds are not subject, including currency risk, political instability risk and local market risk. As with any investment, foreign securities should fit within the investor’s stated objectives and risk tolerance, and should be allocated accordingly.
Preferred securities offer certain benefits of both stocks and bonds. They are most suitable for investors with long-term time horizons who are interested in a fixed rate of return. Unlike common stocks, most preferred securities are issued with a fixed dividend or interest rate, which is typically paid quarterly, and most have a par value of $25 per share. There are three types of preferred securities: traditional perpetual preferred stock, trust preferreds and debt securities. It is important to understand the capital structure and call provisions, and know the circumstances under which the issuer can stop paying out interest income. Since most preferred securities are considered debt and/or are senior to common stock, they enjoy a priority claim over common stock on assets of a corporation in case of liquidation. However, they are often junior to bond holders. Preferreds generally have a much longer maturity than bonds, and in a number of cases they are perpetual. Preferred stocks pay dividends, which must be declared by a board of directors. Additionally, some preferred securities are subject to unique risks, which include the fact that an issuer may defer interest payments for up to 10 years or longer. However, an investor will be liable for income tax on accrued but unpaid "phantom income." Further, dividend payments are not guaranteed and will only be paid if interest payments on the underlying obligations are made first, which are dependent on the financial condition of the issuer. Most preferred securities are callable at the option of the issuer, just like bonds, and may be subject to tax-event or special-event calls. The market value is sensitive to changes in interest rates. Unlike common stocks, preferred stocks do not have voting rights.
Mortgage-Backed Securities and Collateralized Mortgage Obligations Mortgage-backed securities (MBS) have traditionally been referred to as relatively high quality, high cash flow generating investment vehicles. Many of these investments continue to command the attention of investors for the same reasons. However, recent turmoil associated with mortgage loan originations reveals the need to understand these investments and the factors that drive their performance. Many potential investors shy away from MBS, while others consider this an opportune time to invest.
Pass-Through securities represent an ownership interest in mortgage loans made by financial institutions (savings and loans, commercial banks or mortgage companies) to finance the borrower’s purchase of a home or other real estate. Pass-Through securities are created when these loans are packaged, or “pooled”, by issuers or servicers for sale to investors. As the underlying mortgage loans are paid off by the homeowners, the investors receive payments of interest and principal.
A more complex type of MBS is a collateralized mortgage obligation (CMO). CMOs were developed to meet investor demand for more predictable cash flows and specific maturity ranges. These securities can be backed by a pool of mortgages or a pool of existing pass-throughs. CMOs are broken down into classes, called “tranches.” Monthly mortgage payments received from home owners are directed to different classes according to a principal pay-down priority schedule. To learn about different CMO structures, visit the Securities Industry and Financial Markets Association at investinginbonds.com.
To learn more about these types of securities, contact your financial advisor or use the convenient Office Locator to find our office(s) nearest you.