2 of 7 in Series:
The Essentials of Holding and Diversifying Trust Assets
Bonds are pieces of loans, packaged by a corporation or a government as investment product. When you purchase a bond, you’re purchasing a piece of someone else’s debt. In exchange for the money you’re indirectly lending, that debtor agrees to pay you interest.
Bonds are sometimes referred to as fixed-income securities, because the income that they generate for a trust is tied to the stated interest rate on the bond. You’ll receive no more interest than what’s stated, and hopefully, no less. Common types of bonds include corporate, foreign, municipal, U.S. Government, and U.S. Treasury bonds.
When investing in bonds, you’re typically looking to produce a steady stream of income for the income beneficiary. One of most effective ways to achieve that goal is by laddering the maturity dates of the bonds you buy so that bonds mature in sequence, rather than all at once. For example, you may buy one bond that matures in 2009, one in 2010, one in 2011, and so on. By laddering bond maturities, you cushion the income beneficiary from huge drops in his or her income at times when income rates plummet.
Different income beneficiaries have different needs. Some require as much income as you can squeeze out of the trust’s principal. Others want whatever income they receive to be tax exempt. Still others are best served by a combination of approaches. The most common types of bonds and what they can offer both the trust and the beneficiary are as follows:
Corporate: Issued by corporations, these bonds generally carry some of the highest interest rates available. The interest earned is taxable at both the federal and state levels.
Foreign: Other countries borrow money, too, and foreign bonds can be very attractive to investors. What can complicate foreign bonds somewhat is that they’re typically sold, and pay interest in, foreign currencies. Although your brokerage can handle all the currency exchange issues, your return on investment isn’t just dictated by the stated interest rate but also by currency exchange rates. Interest on foreign bonds is taxable at both the federal and state levels.
Municipal: Issued by states, cities, and towns, these bonds carry lower interest rates because they’re exempt from federal income tax, and depending on what state(s) the trust and trust beneficiary pay income tax to, they may also be state income tax free.
U.S. Government: Not to be confused with U.S. Treasury obligations, U.S. Government bonds are the debts of U.S. governmental agencies, such as the U.S. Government National Mortgage Association. These bonds typically pay a slightly higher interest rate than U.S. Treasury obligations, but interest from them is income taxable at both the federal and state levels.
U.S. Treasury: The safest of all investments, these bonds are backed by the full faith and credit of the United States Treasury. In exchange for lending money to the U.S. Treasury, it pays you interest, which is tax exempt in every state, so you pay only federal income tax.
Be very wary of bonds that promise extraordinarily high interest rates. These very high interest rate bonds are sometimes referred to as junk bonds or high-yield bonds. If you’re in a position where you need to generate a large amount of income for your income beneficiary, you may want to venture into this arena, but go very carefully. These bonds carry not only a high interest rate but also a high rate of default. If the bond issuer defaults on the loan, not only do you not get your interest payments, but you’ve also lost your principal investment.
If you’re not sure about a bond you’re considering purchasing, you may want to check that particular bond’s rating, which is essentially a grade assigned to that bond by the rating agencies. The two major agencies, Standard & Poor (S&P) and Moody’s Investor Services, assign ratings when a bond is first issued and then periodically review their ratings based on how the borrower is doing financially.
You can call Moody’s rating desk at 212-553-0377, or you can access Standard & Poor’s ratings by going to Standard and Poor’s and then clicking on “Ratings.” For both services, you need the bond’s identifying number, a nine-digit alphanumeric identifier called its CUSIP Number, in order to check a specific bond. Every publicly traded security has a CUSIP Number. It’s listed on the face of the bond. If the broker holds the trust’s securities, the CUSIP Number appears on the original purchase confirmation or on your monthly or quarterly statement.
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Source:http://www.dummies.com/how-to/content/how-to-invest-in-bonds-for-a-trust.html
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