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Finance: What are the Different Types of Bonds? 424 Views
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What are the different types of bonds? Well, a mortgage is the biggie. Then there are government bonds, which are at the bottom of the risk ladder. Junk bonds are the riskiest, but which also pay the most reward. Somewhere in the middle live corporate bonds. There exist convertible bonds, broken bonds, muni bonds, and yankee bonds, among others to fit all needs.
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Transcript
- 00:00
finance a la shmoop what are the different types of bonds? okay so yeah
- 00:08
insert the Fifty Shades joke here. bonds the kind that won't get you an r-rating
- 00:13
are serious business actually. your grandparents like lived on them or their
- 00:18
interest anyway and they are the lifeblood of American homes. why because [black and white picture of neighborhood]
- 00:22
another fancy word for a bond is mortgage.
Full Transcript
- 00:26
yeah mortgage bonds. yep when you take out a loan to buy a home some mortgage
- 00:30
company aka a bank is creating a bond for you, so you can have that white
- 00:36
picket fence two kids a dog in a room to store all your Star Wars memorabilia. a
- 00:40
bond is a promise. a solemn swear by an individual or an
- 00:45
organization to pay back money loan to them. and the vast majority like well [kids pinkie swear]
- 00:49
over 99% of all bonds made in the US of A pay fully on schedule on time and the
- 00:55
lenders are made whole. despite tons of negative muckraking press we actually
- 01:00
have very few deadbeats in this country. so bonds represent a kind of almost
- 01:04
guaranteed income source for many. they exist as a stabilizing income stream and
- 01:09
with relatively high degrees of safety ie low risk, they understandably carry
- 01:15
less financial reward even generally speaking. and there is a carefully [man goes fishing]
- 01:19
manicured spectrum of risk in bonds. all right let's start with government bonds.
- 01:23
the lowest risk lowest financial return but safest bonds are US government bonds,
- 01:29
which are backed by the country's ability to tax its hard-working citizens.
- 01:33
government bonds and well-funded corporations carry what is called a
- 01:37
A rated paper or A ratings. Yes even governments get credit ratings. [chart showing ratings]
- 01:43
gets riskier the ratings of that bond get lower and lower all the way down to
- 01:48
a category called junk. which are bonds where the interest covering them has
- 01:52
material "iffiness". technical term. Puerto Rico a u.s. territory famously defaulted
- 01:59
on its bonds in 2017 so its credit rating lives [man stands in front of city]
- 02:03
out here. so yeah government bonds are the safest bonds and usually also pay
- 02:08
the lowest interest rate. corporate bonds alright well next on the food chain are
- 02:12
corporate bonds companies put cash in their bank accounts in three basic ways,
- 02:17
they sell equity or ownership or shares or stock in themselves like in an IPO.
- 02:23
they can also make money from selling their product that is a single shingle
- 02:27
sells for 19.95 and they keep $4 in 82 cents and profits from it times 10 [birds on a roof]
- 02:33
million and you know that's a lot of cash from shingles. and C they put cash
- 02:36
in their coffers by selling bonds or selling debt. that is they pay rent for
- 02:42
borrowing the cash money just as government's do. what do Microsoft Koch
- 02:46
and your deadbeat uncle all have in common well they all have debt
- 02:51
outstanding. most companies like well over 99% of them boringly pay off all [long haired man frowns from the couch]
- 02:56
their interest and when the bonds come due however many years or decades later
- 03:00
they pay the principal and they're done. they presumably use the money wisely but
- 03:05
the more interesting Bond stories revolve around the times when company's
- 03:08
best laid plans go awry and they snuggle up real close next to bankruptcy. if our
- 03:17
roofing company we've got shingles has ninety million bucks in pre-tax profits
- 03:22
they might have one point six billion dollars of bonds with an interest rate
- 03:25
of 5% well the interest costs are 80 million dollars a year so the company is [equations]
- 03:30
only making 10 million bucks. just enough to cover the interest should the profits
- 03:36
fall well the company would go into default, they'd miss an interest payment
- 03:40
and then in theory the bondholders could a well, just repossess the company.
- 03:44
the bondholders would control the company sell off assets to pay
- 03:48
themselves back their loans, and well then the company usually dies. so that's [man carries buckets of shingles]
- 03:52
not good and that's why the bonds are called junk, or in more proper parlance
- 03:57
high-yield. they live way to the right on the risk spectrum because that whole
- 04:01
snuggling up right next to bankruptcy thing is not something Wall Street
- 04:05
people like doing .childhood intimacy issues I guess. so while a very safe US
- 04:10
government 10-year bond might pay 3% interest a similar but very junky junk
- 04:15
junk junk corporate bond my pay 12% or more to adjust for the very
- 04:20
high degree of risk. there are other flavors of funds as well, one highly [corporate bond pictured]
- 04:25
popular bond with high tax payers are muni bonds. 8k a municipal bonds yep.
- 04:31
they're a special class a bond generally created so that local areas can fund
- 04:35
projects important to their community. like parks and parking structures and
- 04:40
sports arenas. they're structured just like corporate and government bonds and
- 04:44
that they have principal, the amount being borrowed, and a rental rate or
- 04:47
interest rate for renting the money. the one key difference no tax yeah. say that
- 04:52
again. sweet sweet music. no tax .whereas government corporate bonds are taxable
- 04:58
Muniz generally are not. well why the big break because the feds wanted local [chart]
- 05:03
people to really care about the local financial health of whatever
- 05:06
infrastructure they were building locally. so the federal government
- 05:10
doesn't have to get its hands dirty in city activities, whether that's building
- 05:14
a new field for the local baseball team or supporting a local park that's been [man folds arms in front of construction site]
- 05:19
down and out because the roofing company who built the little shack that housed
- 05:22
all the toys in it caved in. so as you can see there are more varieties of
- 05:26
bonds than there are flavors in an ice-cream shop, even if none of them hit
- 05:31
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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