Types of Funds

Bonds can be broken down into a number of categories, each with slightly different characteristics. 

The first categorization depends on the bond issuer:

  • Government bonds:  These are bonds issued by a government in its own currency to finance spending.  Some of the best known government bonds are the German Bundesanleihen or Bund, United Kingdom-issued Gilts, U.S. Treasury Bonds, and French OATs (Obligations Assimilables du Trésor). All these government issues are considered high quality, which means the risk of default is exceptionally low.
  • Bonds issued by government-owned companies:  These bonds are issued by government agencies or local governments.  They offer safety, but at a lower level than government bonds. Local government bonds are ranked from good quality to poor quality.
  • Corporate bonds or non-profit organizations’ bonds: These bonds typically offer higher interest rates than government bonds, according to their risk level. The risk level is determined by the financial health of the issuer, company or organization.

Bonds are also categorized by how interest is paid:

  • Fixed rate bonds are the most typical. A fixed rate bond pays interest (or coupon), at a predetermined rate. Interest is payable at specified dates (most commonly once a year) until bond maturity.
  • Floating rate notes (FRNs).  These are bonds that have a variable coupon, most commonly tied to a money market rate, like LIBOR or EURIBOR, plus a spread at a constant rate. Most FRNs have a low rate risk; but this risk can be higher when the reference is a long-term rate.
  • Inflation linked bonds:  With inflation linked bonds, the principal amount and the interest payments are indexed to inflation. Their interest rate is usually lower than for fixed rate bonds with a comparable maturity. The coupon is reevaluated in order to maintain its value in time, and keep a consistency with the date of issue. Inflation linked bonds enable investors to protect their investment’s purchasing power.
  • Zero-coupon bonds: These bonds pay no regular interest during their lifetime. Coupons are capitalized and integrally redeemed at maturity, with the full principal amount. Zero-coupon bonds enable individual investors to capitalize their savings’ revenues, in order to finance predictable expenses at a future date.

Finally, there are some variations of bonds:

  • Convertible bonds. A convertible bond is a fixed-rate bond that may, at the option of the investor, be converted into equity shares of the borrower. The price at which the bond is convertible into equity is set at the time of issue. This price typically will be at a premium to the market value of the underlying equity at the time of issue.

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