Bonds are debt securities similar in function to IOUs. Governments, agencies and companies all issue bonds, in essence taking out a loan for a specified amount of time. The bondholder receives periodic fixed payments — called coupons — until the issuer repays the bond in full. A handful of bonds, called zero-coupon bonds, do not pay periodically, but are issued at a deep discount to face value and are ultimately repaid at face value.
Bond payments are based on the terms of the issue, among which are duration of the bond, the interest rate environment and credit ratings. Independent ratings agencies determine the creditworthiness of bond issuers, assigning each issuer a rating (however, not all bonds are rated). The interest rate environment at the time of issuance also plays a role in determining bond payments; however, changes in rates or credit ratings don’t change the payments once established. Changes in rates or credit ratings do, however, affect the value of the bonds after they’re issued.
Below are the different types of bonds available to the majority of investors.
U.S. Department of the Treasury
Highly rated, backed by the full faith and credit of the U.S. government.
Bond rating depends on company’s solvency and prospects.
Government agencies, non-governmental enterprises, some banks
Bonds issued against a pool of existing mortgages; many agency mortgages from government agencies and non-governmental entities are backed by the U.S. government.
U.S. state and local governments
Ratings depend on fiscal health of issuer; income from these bonds is often free of federal tax and some state taxes as well, depending on the issuer.
Banks and companies
Bonds issued against a pool of loans, such as auto loans or credit cards.
Bonds issued by foreign governments; may be in dollars or local currency.
Developing-country governments and corporates
Issued by governments, government-related entities and corporates in emerging markets across the world, mostly in dollars or local currency.
Also known as ”junk bonds,” these are issued by companies with low credit ratings. While they generally offer a higher yield than investment-grade bonds, high-yield bonds also carry a higher risk of default.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
The return of principal for bond portfolios and for portfolios with significant underlying bond holdings is not guaranteed. Investments are subject to the same interest rate, inflation and credit risks associated with the underlying bond holdings.
This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.