Munis, Notes, Maturity: A Bond Primer

· What are the different types of bonds?

There are several types. Most bonds are issued by the U.S. government and its agencies, state and local governments or corporations. Let's take a look at these.

1) U.S. government bonds: You can buy either bills (maturities range from 90 days to a year), notes (2 to 10 years) or bonds (10 to 30 years). They are considered the safest bets. The U.S. government probably won't default on this loan because it can always raise tax revenue to pay back its debt obligations. Another plus: Any income you earn is exempt from local and state taxes. The downside is that because they are not as risky an investment, their interest rates are lower. Of the types of Treasurys you can get, the longer-term ones will have the highest interest rates simply because you have to wait longer to get repaid.

You can also get bonds from government-backed agencies such as the Tennessee Valley Authority and Sallie Mae. They have higher yields but are generally only available through brokers who charge commissions.

2) Municipal bonds: State and local governments issue these bonds to pay for school construction projects, water and sewer upgrades, etc. In exchange for investors' backing, the federal government won't tax the interest on these bonds. Many municipalities also will exempt investors from state and local taxes on these bonds. Because of this, the yield is usually lower than that of a taxable bond. And munis, as they are called, carry some risk. Cities can go bankrupt, after all.

3) Corporate bonds: These offer higher interest rates than government bonds, but buying them typically requires you to go through a broker and pay a commission. Many corporate bonds are also callable, meaning the company can pay off the debt early. Furthermore, corporations, unlike governments, are more likely to go bankrupt. Hence, the lower the credit quality, the higher the interest you're paid.

· How do you buy bonds?

You can buy individual bonds or bond funds. Most bond transactions are done through a full-service or discount brokerage. You can also get an investment adviser to sort it out for you. Keep in mind that the broker or dealer will probably include a mark-up. You can protect yourself from this by finding out the latest quote on a bond. This is easily done on the Internet.

The best way to buy U.S. government bonds is to go to http://www.treasurydirect.gov or to contact your nearest Federal Reserve Bank. Through the government's Treasury Direct program, you can buy these bonds without paying commission.

If you don't want to go through the hassle of buying individual funds, try a bond fund, which offers you diversification. The fund managers are constantly trading bonds depending on market conditions, so there are no maturity dates. You can withdraw your money whenever you want. But because the trading is constant, the value of your investments could be higher or lower when you pull out.