Who Issues Bonds ?

A bond is a long-term contract under which a borrower agrees to make payments of interest and principal, on specific dates, to the holders of the bond. Fox example, on January 2, 1998, Allied Food Products borrowed $50 million by selling 50,000 individual bonds for $1,000 each. Allied received the $50 million, and in exchange it promised to make annual interest payments and to repay the $50 million on a specified maturity date.

Investors have many choices when investing in bonds, but bonds are classified into four main types: Treasury, corporate, municipal, and foreign. Each type differs with respect to expected return and degree of risk.

Treasury bonds, sometimes referred to as government bonds, are issued by the federal government¹. It is reasonable to assume that the federal government will make good on its promised payments, so these bonds have no default risk. However, Treasury bond prices decline when interest rates rise, so they are not free of all risks.

Corporate bonds, as the name implies, are issued by corporations. Unlike Treasury bonds, corporate bonds are exposed to default risk-if the issuing company gets into trouble, it may be unable to make the promised interest and principal payments. Different corporate bonds have different levels of default risk, depending on the issuing company’s characteristics and on the terms of the specific bond. Default risk is often referred to as “credit risk”, the larger the default or credit risk, the higher the interest rate the issuer must pay.

Municipal bonds, or “munis”, are issued by state and local governments. Like corporate bonds, munis have default risk. However, munis offer one major advantage over all other bonds: the interest earned on most municipal bonds is exempt from federal taxes, and also from state taxes if the holder is a resident of the issuing state. Consequently municipal bonds carry interest rates that are considerably lower than those on corporate bonds with the same default risk.

Foreign bonds are issued by foreign governments or foreign corporations. Foreign corporate bonds are, of course, exposed to default risk, and so are some foreign government bonds. An additional risk exists if the bonds are denominated in a currency other than that of the investor’s home currency. For example, if you purchase corporate bonds denominated in Japanese yen, you will lose money-even if the company does not default on its bonds if the Japanese yen falls relative to the dollar.