Corporate Bonds versus Government Bonds

Government bonds and corporate bonds have different terms, risks, and returns.

Corporations are not the only entities that can issue bonds. Government entities can offer a government bond, which is a debt security issued by a government, whether local, state, or federal, including U.S. Treasury bonds and municipal bonds. A government entity such as a county or city that has a local government, might issue a bond for a specific purpose. For example, a city may want to build a school. After an approval vote, the city can issue a bond against its tax revenue. The cash will be used to build the school, and the bond will be repaid by special taxes that are collected. Government entities are considered to have a lower risk for default because they are backed by the credit of the government itself, which in many cases has a lower risk of default as compared to a private company. Municipal bonds do carry some, low risk of default. Therefore, a government bond is deemed a safer investment than a corporate bond. A corporate bond is a debt security issued by a company in order to raise capital through debt.

Bonds issued at the federal level are the safest type of bonds, as they are backed by the full faith and obligation of the United States. The Treasury issues bonds called Treasury bonds, or T-bonds. Because of their low risk of default, T-bonds are considered risk-free. The maturity date is greater than 10 years but less than 30 years, and T-bonds have a fixed interest that is paid twice per year. Treasury bonds are offered at auction, usually in increments of $100. The yield to maturity (YTM), or the return on a bond from the date of purchase through the date of maturity, expressed as an annual percentage, will affect the auction price of the bond. If the YTM is less than the interest rate that the bond will pay, the price of the bond will be higher than the face value. If the YTM is greater than the interest rate, then the price will be less than the face value. Because Treasury bonds are used as the basis of comparison for company bonds, the return that the Treasury bonds offer, called the bond yield, is carefully tracked. The rate that they pay will depend on the economy as well as the maturity. After a purchaser buys the bond, it may be resold on a secondary bond market. The bond market is the marketplace where participants trade new debt or buy and sell debt securities. More specifically, the bond market, also known as the debt or credit market, is a financial market where participants can issue and trade new debt, known as the primary market, or buy and sell debt securities, known as the secondary market.

Bond Yields over Time

The maturity of the bond will affect the interest rate, which in turn sets the value of the bond. Interest rates were high in the 1980s, corresponding to high real estate prices.
Because risk and return are related and Treasury bonds have a low risk of default, they are a better choice than corporate bonds for a risk-averse investor. Corporate bonds pay a premium for taking on the risk of default. This means that they have a greater YTM than government bonds.

A callable bond is a type of debt security in which the issuer has included the option to repurchase the bond before its maturity date. It is far more common for corporate bonds to be redeemable than Treasury bonds because corporate bonds have greater risk than many types of bonds because they are backed by the individual company and not the United States. Callable bonds have higher coupon rates than noncallable bonds and callable corporate bonds are favored by investors looking for the highest return, as they offer the highest return at a lower risk due to the interest rates offered on corporate bonds are higher than other bonds. Corporate bonds are rated based upon the financial strength of the company.