Page 79 - Encyclopedia of Business and Finance

eobf_B 7/5/06 2:55 PM Page 56

Bonds

sale of the bonds, and in the secondary market, which is face value at maturity. Price and yield are determined at
the sale of bonds subsequent to the initial sale by the auction. Both noncompetitive and competitive bids are
issuer or underwriter. While the stated rate is the same accepted. Choosing a noncompetitive bid means that the
throughout the life of the bond, the effective rate varies buyer accepts the interest rate determined at auction and
with the buying and selling of corporate bonds in the sec- the buyer is guaranteed to receive the bond in the full
ondary market. amount requested. Such a bid may be made through Trea-
An investor who wishes to buy or sell corporate suryDirect (http://www.savingsbonds.gov), a government
bonds must contact a broker or dealer who might carry Web site that is run by the Bureau of the Public Debt, part
that particular bond in inventory. A dealer who does not of the U.S. Department of the Treasury. A competitive bid
have that bond would contact another dealer who did. requires that the buyer use a bank, broker, or dealer. With
Many major newspapers report information about bonds, a competitive bid there is uncertainty of about whether
both corporate and U.S. government bonds. the buyer will be accepted or, if accepted, will get the
number of bonds requested. These bonds are available
Rating of Corporate Bonds. There are three organizations only in electronic entries in accounts.
that rate corporate bonds: Fitch Investors Service,
Moody’s Investors Service, and Standard & Poor’s Corpo- I Bonds and EE Bonds. I bonds and EE bonds are not
ration (S&P). Each has a ranking system. For example, typical bonds. They are available in small denominations.
S&P uses AAA as the highest ranking, meaning in general They can be purchased at local banks and other financial
that bonds so ranked are issued by corporations that are institutions, as well as through TreasuryDirect, and some-
judged to have extremely strong capacity to pay interest times through payroll deductions.
and to repay the principal. S&P’s lowest ranking is D, I bonds, whose rate of return is tied to the inflation
which indicates that the corporation’s bonds are in rate, may be purchased in denominations of as little as
default, and payments are in arrears. Between the two are $50. I bonds are a low-risk, liquid savings product. They
AA, A, BBB (all indicating levels of adequate assessments), are available through TreasuryDirect or payroll deduction,
with AA being higher than A, and A higher than BBB. as well as at most local banks and other financial institu-
Bonds rated BB, B, CCC, and CC are predominately tions. These bonds earn interest from the first day of their
speculative, with the lower ratings often referred to as issue month. They are an accrual-type security, which
junk bonds or high-yield bonds. C is reserved for bonds means they increase in value monthly and the interest is
no longer paying interest. paid when they are cashed. They can earn interest for up
to thirty years. The I bond’s interest is based on a compos-
ite rate that is a fixed rate for the life of the bond and an
FEDERAL GOVERNMENT BONDS
inflation rate that changes twice a year.
The U.S. federal government borrows large amounts of
money in order to meet its obligations. The U.S. Treasury EE bonds are popular, low-risk savings products with
interest rates based on a fixed rate of return. EE bonds are
issues a number of debt obligations in addition to bonds.
available at the TreasuryDirect Web site. If purchased elec-
Securities with maturity dates of less than a year are called
Treasury bills (or T-bills); those with maturities from one tronically, EE bonds are sold at face value, which means
to ten years are called notes; those with maturities exceed- the buyer pays $50 for a $50 bond. Purchases in amounts
of $25 or more, to the penny, are possible.
ing ten years are generally called bonds. There are I bonds
and EE bonds, however, that may be redeemed at any Paper EE bonds are also available. The price is 50 per-
time after a twelve-month-minimum holding period. Col- cent of face value, that is, $25 for a $50 EE bond. Buyers
lectively, the issues of the U.S. Treasury are referred to as are issued bond certificates. Paper EE bonds are purchased
Treasuries. through local banks, other financial institutions, or
through an employer’s payroll deduction plan, if available.
Federal government bonds are auctioned according to
a schedule that is posted at the Treasury’s Web site
(http://publicdebt.treas.gov), after announcements at MUNICIPAL BONDS
press conferences. The bonds available are varied. A State, county, and local governments also borrow money
description of a limited number of what is available fol- by selling municipal bonds (frequently referred to as
lows: “munis”). Municipal bonds are either general obligation
or revenue bonds. The principal of general obligation
Thirty-Year Treasury Bonds. The U.S. Treasury sells bonds (also known as “GOs”) is paid from tax payments
thirty-year bonds twice a year. These bonds pay interest from citizens and from user fees for services provided by
every six months until maturity. The bondholder receives the political unit. The costs of building schools and sew-

56 ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION