A bond is a loan that the bond purchaser, or bondholder, makes to the bond issuer.
Government (Federal, States and Local government) and corporations issue bonds when they need capital.
If you buy a government bond, you are lending the government money. If you buy a corporate bond, you are lending the company money.
There are a huge number of bonds issued each year. But there are only a few types of bonds because one way or the other, the majority of bonds issued falls into the categories of bonds listed below.
1. Treasury Bonds
This bond is issued is issued by the federal government. Treasury bonds are the safest bonds out there, that is, depending on the government of a country issuing it.
The bonds of the United States of America cannot be ranked the same in risks with Nigerian bonds because the USA as a country is more stable than Nigeria both politics and economics.
Treasury bonds have the lowest yields compared with other types of bonds because they are almost safe and in investment and finance, the safer an asset, the lower the yields.
Nigeria as at 31st March 2017 has a total of 19 trillion naira in debt, according to Debt Management Office. This stock of debt is mostly made up of bonds issued abroad and bonds issued here in Nigeria.
2. Municipal Bonds
These are bonds issued by states and local governments to finance its capital expenditures which include construction of roads, bridges, power plants and grids, the building of schools, hospital etc.
States differs in term of size, economy, and security, so the risk investors are willing to take on these states differs.
Take for instance, Lagos State and Borno State. Lagos is a better secured and more wealthy. Therefore an investor presented with an option to buy the bonds of Lagos State and that of Borno will definitely go for that of Lagos State.
Investors want to be assured that they can at least be able to get out with their principal in case anything happens so the safer your state or local government, the more they will invest in it and at a lower cost the state or local government.
3. Corporate Bonds
These are bonds issued by companies to raise capital to improve their businesses.
A company can issue bonds for many reasons including buying another company, paying dividends to shareholders, expansion and to fund new business ventures.
Corporate bonds have more credit risks than Treasury bonds and municipal bonds because Treasury bond defaults are rare like the recent Argentina’s credit default, municipal bond defaults happen but they are few. But corporate bond defaults happens regularly.
Corporate bonds can be divided into investment grade and speculative grade.
An investment grade bonds are rated higher by rating agencies and they are relatively safe.
Bonds of companies like Dangote group, GTbank, and First Bank can be ranked in that category. When you are buying the bonds of these companies, you know that they are big enough and have enough assets on their balance sheet to pay their debts.
Speculative grades rate lower because they are new companies, companies in a volatile sector or companies that have lots of debts on their balance sheet. They have a high risk of default, particularly in a recession.
4. Asset-Backed Securities
Asset-backed securities are bonds backed by financial assets.
They are bonds in which assets are bundled together and resold to investors as bonds.
A major example of asset-backed security is mortgage-backed securities (MBS). These bonds are created from the mortgage payments of residential homeowners.
If you took a mortgage from Imperial Homes Mortgage bank, the bank can repackage your loan and that of others and sell it to investors.
These investors can now provide the capital that will help fund your home.
Mortgage banks most of the time do not have enough capital required to fund home. So what they do is that they serve as middlemen between you, the home buyer and the investors.
If you declare an interest that you want to buy your own home, the banks will note your interest and that of other people, pool them together, then inform investors (most times institutional investors like pension funds, big banks, hedge funds, mutual funds etc).
These institutional investors will now provide the long-term funds capital needed to fund your home.
In the same way, car loans can be bundled together and resold to investors.