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The four most popular types of fixed-income securities issued by the U.S. Treasury are Bills, Notes, Bonds and TIPS (Treasury Inflation-Protected Securities). Bills have maturities of three months to one year, and are sold at a discount since the interest rate is equal to the difference between the purchase price and the principal amount an investor would receive at maturity (interest basically accrues to face value rather than being directly paid out to investors). Notes pay interest semi-annually and are issued in two-year, five-year and ten-year maturities. Bonds are issued with 30-year maturities and also pay semi-annual interest.

TIPS provide bond investors with a hedge against inflation since they pay an interest rate that is periodically adjusted according to changes in the Consumer Price Index (CPI).

U.S. Treasury STRIPS (Separate Trading of Registered Interest and Principal of Securities)are also a popular government investment. Much like bills, STRIPS are sold at a discount to face value, since the interest accrues to the face value of the security rather than as a semi-annual payment to the bondholder. Unlike bills, though, STRIPS offer investors a wide range of longer-dated maturities to choose from.

Agencies

U.S. federal agencies, which are fully owned by the U.S. government, and Government-Sponsored Enterprises (GSEs), which are privately owned entities created by Congress, together issue debt securities known as Agencies. This implicit connection to the federal branch has led Agency structures to be considered second in quality only to U.S. Government securities. Agencies use the proceeds raised in the capital markets to provide funding for public policy purposes, such as housing, education and farming.

GSEs are the most active issuers in the Agency market. You might be familiar with the two largest shareholder-owned companies: Fannie Mae and Freddie Mac.

Mortgages

Mortgage-backed securities, commonly known as mortgages, are bonds created from mortgage loans. These loans are originated by a variety of financial institutions in order to provide financing for home loans and other real estate. Mortgage lenders typically package, or «pool», these loans and then sell them to mortgage-backed securities issuers. The bonds are generally issued in multiples of $1,000.

At approximately $2.5 trillion in outstanding securities, mortgages are now a major segment of the US bond market. Mortgage bonds generally retain high credit quality since most are either explicitly, or implicitly, backed by the federal government.

Mortgage securities are generally classified as either pass-throughsor

Collateralised Mortgage Obligations (CMOs). Pass-throughs basically collect mortgage payments from homeowners and pass this cash flow onto investors. CMOs provide a more predictable payment stream than pass-throughs by creating separate «tranches», designed to meet different investment objectives.

Corporates

Public and private companies issue corporate bonds, commonly known as corporates in order to meet both short– and long-term financing needs. The proceeds from a bond sale are therefore used for a wide variety of purposes, such as for the purchase of new equipment, the funding of general operating expenses or for the financing of a company M&As. Corporates are typically issued in multiples of $1,000, have a maturity range between one and 30 years and pay semi-annual interest. The vast majority of corporate bonds are fully taxable.

Corporate Bond Credit Quality

Credit quality is the most important concern for corporate bond investors. Most corporates are assigned credit ratings by Moody’s and S&P. These ratings classify an issuer as «high-grade» or «high-yield». High-grade bonds are considered fairly conservative investments since these companies are deemed to be in good financial health and are unlikely to have trouble meeting their debt obligation. These bonds are rated from «Aaa» to «Baa» by Moody’s, and from «AAA» to «BBB» by S&P.

High-yield bonds are considered speculative since they are issued by companies with more credit risk. These bonds are rated on a scale from «Ba» to «C» by Moody’s, and from «BB» to «D» by S&P. These bonds pay a higher rate of interest – and have a potentially higher rate of return – than their high-grade counterparts. However, high-yield bonds are only appropriate for risk-tolerant investors.

Municipals

States, cities, counties and towns issue municipal bonds. The proceeds from bond sales are used for the building and maintenance of a variety of public works projects – such as for the construction of schools, roads, hospitals and sport stadiums.