Zero-coupon Bonds
Article Provided by FinancialContent
By Chris Stallman
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With so
many different types of bonds, it's no wonder that they can
be so confusing. Three common types of bonds are Treasury Bills
(T-Bills), Treasury Notes (T-Notes), and Treasury Bonds (T-Bonds).
As their
names suggest, all of these bonds are issued by the United States
Treasury. What this means is that the government sells these bonds
to the public in order to raise money to run the country. Investors
buy these bonds in hope to make money from them in the form of interest.
And although these bonds all have similar names and are sold to
the public by the US Treasury, there are some notable differences.
T-Bonds
These are probably
the most common types of bonds that small investors are used to
seeing. T-Bonds are long-term debt issues that don't mature
for at least 10 years and act as major funding to keep government
operations running. T-Bond investors earn interest on their money
and when the bond matures, they earn the full value of the bond
back.
New issues of
T-Bonds are sold to the public by auctions at Federal Reserve Banks.
However, most investors purchase them through their brokers after
they have been issued.
T-Bonds
are very safe investments because they are backed by the federal
government. What is also nice about these bonds is that they are
exempt from local and state taxes, although you still have to pay
federal taxes on the income.
Although they are safe investments and offer a couple
tax advantages, they usually generate lower interest rates than
corporate bonds (bonds issued by companies). Also, new issues usually
require a minimum investment of $1,000.
T-Notes
T-Notes are
a lot like T-Bonds. Like T-Bonds, T-Notes are exempt from state
and local taxes and offer maximum safety to the investor because
they are backed by the federal government. They also pay low interest
rates and are sold by the Federal Reserve Banks.
The only real difference between the two is that T-Notes
are shorter-term investments. T-Notes usually carry maturity dates
of anywhere between 2-10 years and offer investors a short-term
alternative to investing in bonds.
T-Bills
When it comes to short-term investing in bonds, these
are the types of bonds that you go for. These short-term investments
have maturity dates of 3 months, 6 months, and one year.
The government sells these bonds in the same fashion
as T-Bonds and T-Notes. However the money that the government generates
is used for immediate spending rather than funding the government
in the long-term.
Unlike T-Bonds and T-Notes, these bonds don't pay
interest to their holders. Instead, the investor profits by the
increase of the bond's price from the time they bought it and
its value at maturity.
Unfortunately, these bonds usually aren't issued
to small investors because they often carry minimum investments
of $10,000 or more. However, many money market accounts carry these
bonds to generate interest for the investors. Also, mutual funds
that are referred to as "short-term bond funds" usually
hold a large portion of their portfolio in these bonds.
Although all these forms of bonds offer a large degree
of safety, they have historically underperformed the stock market
year after year. It might be wise to invest in some T-Bonds or T-Notes
to lower your risk and help you sleep better at night but when it
comes to investing for the long-term, it's probably best to
keep most of your portfolio invested in stocks and/or mutual funds.
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