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Bonds: Bond Types

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So far we have been talking about what are known as 'straight' or 'plain vanilla' bonds. But there are a lot of different types of bond, and they are differentiated in a lot of different ways.

One of the most important considerations for the private investor is, of course, who the issuer is.

Governments

Governments are the largest issuers of bonds in the world and, rather confusingly, the bonds they issue are usually referred to as 'governments’.

Government bonds have a more or less zero risk of default and this, combined with the massive volume issued and the sameness (the homogeneity) of the structure of government bonds, means they can be easily bought and sold – they are what is called, liquid.

This also means they provide a benchmark for other types of bond issue. Government bonds provide what is called a ‘riskless rate of return’. And this is a useful guide to what sort of return a bond has to offer as the level of default risk rises. So, for example, if a French government bond has a zero risk of default, what risk of default does a bond issue by a French corporate have in comparison?

A final point to note about ‘governments’ is that – unlike other types of bond issue, which tend to be passively held - they are an actively traded market. This too stems from the volume and sameness of what is issued – the liquidity of the market.

Corporates

The corporate bond market is the second largest in terms of volumes. Issuers can place paper in their own domestic market or they may widen their investor base by issuing in a foreign market or in the international market - the Euromarket - in any number of currencies.

Investors require a credit analysis to decide upon the suitability of the credit premium offered above the corresponding government issues of comparable maturity - as reflected in the yield spread - to determine the attractiveness of the investment opportunity.

The corporate bond market is tiered in much the same way that the equity market is. In the equity market it is more intuitive though; you have got big companies, medium size companies, small companies, start-up companies and so on - and different market segments are deemed more or less risky on the basis of their market capitalisation.

In the bond markets - because the credit rating agencies actually assign a credit rating to each bond - this sort of tiering is much more formalised. You know what level of credit risk is attached to a particular corporate bond because the rating agency's rating tells you. The higher the risk, the higher the return. And once you get involved with high yield bonds  (formally known as 'junk', now known as 'non-investment grade'), that is a lot of risk.



Equity Risks

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