Investing in Bonds: The Wider Bond Market

Bonds are surely an important part of every investor's portfolio, especially those who are approaching retirement. However, investors should be aware of the default risk associated with their chosen bond along with variation in inflation and subsequent real returns. Considered as the purest type of bond, Treasury bonds have no credit risk attached to them. The range of bonds available in the U.S. bond market is corporate bonds, mortgage-backed bonds, and tax-exempt municipal bonds. Corporate bonds have a higher default risk than U.S. Treasury bonds and so their bond yields are higher. The difference between Treasury bonds and corporate bonds is that the former are exempt from state and local income taxes, while the latter are not. The returns on corporate bonds and other bonds are examined in detail. Default risk is of prime importance when pricing high-yield bonds. These bonds are riskier than investment grade corporate bonds. When recessions occur, high-yield bonds suffer large capital losses and so these bonds are very sensitive to business cycles. This chapter considers three types of bonds, including U.S. taxable bonds issued by corporations and other entities, Treasury Inflation-Protected Securities (or TIPS), and tax-exempt municipal bonds.