IBONDS
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IBONDS
What are IBONDS?
IBONDS are investment securities in which an investor lends money to a company or government for a set period of time, in exchange for regular interest payments. Once the bond reaches maturity, the bond issuer returns the investor's money. The term fixed income is often used to describe bonds, as their investment generates fixed payments over the life of the bond.
Companies sell bonds to fund ongoing operations, new projects, or acquisitions. Governments sell bonds for financing purposes and also to supplement tax revenues. When you invest in an IBONDS, you are a debt holder of the issuing entity with the added benefit that IBONDS are based on IRAIC contracts that guarantee a real asset for such issuance.
Many types of bonds, especially investment grade bonds, are lower risk investments than stocks, making them a key component of a complete investment portfolio. IBONDS, being private and decentralized, can help hedge the risk of more volatile investments like stocks, and can provide a steady stream of income during your retirement years while preserving capital by being backed by the real asset.
Key Terms to Understand IBONDS
Before we look at the different types of bonds and how they are quoted and traded in the market, it is helpful to understand the key terms that apply to all bonds:
Maturity: The date on which the bond issuer pays back the money lent to it by bond investors. Bonds have short, medium, or long-term maturities.
Face Value: Also known as par, face value is the amount your bond will be worth at maturity.
The face value of a bond is also the basis for calculating the interest payments owed to bondholders. Bonds typically have a face value of $1000.
Coupon: The fixed interest rate that the bond issuer pays to its holders. Using the $1000 example, if a bond has a 3% coupon, the bond issuer promises to pay investors $30 per year until the bond's maturity date (3% of $1000 face value = $30 per year).
Yield: The rate of return on the bond. While the coupon is fixed, the yield is variable and depends on the bond's price in the secondary market and other factors. Yield can be expressed as current yield, yield to maturity, and yield to maturity.
Price: Many, if not most, bonds are traded after they are issued. In the market, bonds have two prices: bid and ask. The bid price is the highest amount a buyer is willing to pay for a bond, while the ask price is the lowest price offered by a seller.
Duration risk: This is a measure of how the price of a bond might change as market interest rates fluctuate. Experts suggest that a bond will decrease 1% in price for every 1% increase in interest rates.
The longer the duration of a bond, the more exposure its price has to changes in interest rates.
Rating: Rating agencies assign ratings to bonds and bond issuers, based on their creditworthiness.
Bond ratings help investors understand the risk of investing in bonds.
Investment grade bonds have ratings of BBB or better.
What are the different types of Bonds?
There is an almost endless variety of types of bonds. In the U.S., investment grade bonds can be categorized into four types: corporate, government, agency, and municipal bonds, depending on the entity issuing them. These four types of bonds also feature different tax treatments, which is a key consideration for bond investors.
Corporate Bonds
Corporate bonds are issued by public and private companies to fund daily operations, expand production, fund research, or finance acquisitions. Corporate bonds are subject to federal and state income taxes.
Government Bonds
U.S. government bonds are issued by the federal government. They are commonly referred to as Treasury bonds, because they are issued by the U.S. Treasury Department. Money raised from the sale of Treasury bonds funds all aspects of government activity. They are subject to federal taxes but exempt from state and local taxes.
Agency Bonds
Government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac issue agency bonds to provide funding for federal mortgage, education, and farm loan programs. These bonds are subject to federal taxes.
Federal taxes, but some are exempt from state and local taxes.
Municipal bonds
States, cities, and counties issue municipal bonds to fund local projects. The interest earned on municipal bonds is tax-free at the federal level and often at the state level as well, making them an attractive investment for high-net-worth investors and those seeking tax-free income during retirement.
Bond characteristics
We can classify bonds based on how they pay interest and other characteristics:
Zero-coupon bonds: As the name suggests, zero-coupon bonds make no periodic interest payments. Instead, investors purchase zero-coupon bonds at a discount to their face value and receive the full face value at maturity.
Callable bonds: These bonds allow the issuer to pay off the debt (or "call the bond") before the maturity date. Call clauses are agreed upon before the bond is issued.
Puttable Bonds: Investors have the option to redeem a puttable bond (also known as a call bond) before the maturity date. Puttable bonds can offer one or more positions.
Several different dates for early redemption.
Convertible Bonds: These corporate bonds can be converted into stock of the issuing company before maturity.
IBONDS: These bonds have the power to absorb all types of bonds existing in the market as long as they are backed by a real and solid asset, within the private and decentralized market.
Investors work with their Registered Investment Advisor to help select the IBOND that provides income, tax advantages and features that make the most sense for their financial goals.
How do bond ratings work?
All bonds carry the risk of default. If a corporate or government bond issuer declares bankruptcy, that means it will likely default on its bond obligations, making it difficult for investors to recover their capital.
Bond credit ratings help you understand the default risk involved in your bond investments. They also suggest the likelihood that the issuer will be able to reliably pay investors the coupon rate of the bond.
Just as credit agencies assign you a credit rating based on your financial history, credit rating agencies assess the financial health of bond issuers.
Generally speaking, the higher a bond's rating, the lower the coupon should be due to the lower risk of default by the issuer. The lower a bond's ratings, the more interest an issuer must pay to investors to entice them to make an investment and offset the higher risk.
IBONDS do not require rating as IRAIC ensures that the IBONDS are backed by the real asset to cover its risk of potential bankruptcy filings.
How are IBONDS priced?
Bonds are priced in the secondary market based on their face or par value. Bonds priced above face value (above par value) are said to be trading at a premium, while bonds priced below face value (below par value) are trading at a discount. Like any other asset, bond prices are driven by supply and demand. But credit ratings and market interest rates also play a role in pricing.
IBONDS are priced just like traditional bonds but with the difference that they are more heavily backed.
Consider credit ratings: As noted above, a high-rated investment-grade bond pays a smaller coupon (a lower fixed interest rate) than a low-rated bond below investment grade. That smaller coupon means the bond has a lower yield, giving you a lower return on your investment. But if demand for your high-rated bond suddenly plummets, then it would start trading at a discount to face value in the market. However, their yield would increase and buyers would earn more over the life of the bond, because the fixed coupon rate represents a larger portion of a lower purchase price.
IBONDS do not suffer from the complexity of ratings as our IBONDS pay a standard coupon from their registration due to the leverage of the real asset.
Changes in market interest rates add to the complexity. As market interest rates rise, bond yields also rise, depressing bond prices.
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