Bond Types

Bonds can have many features that can play different roles in a well-diversified portfolio. At Trackinsight, we identified 8 different bond types: fixed rate, floating rate, covered, convertible, inflation-linked, Mortgage-Backed Securities (MBS), Credit Default Swaps (CDS) and overnight rate.

1. Fixed Rate

Fixed-rate bonds pay fixed coupons during their whole lifespan. Most of the Fixed Income ETF universe is composed of fixed-rate bonds.

2. Floating Rate

Floating-rate bonds have their coupon linked to an interest-rate reference such as the LIBOR. The coupons they pay are not fixed during the life of the bond and reset frequently to reflect the variation of the reference rate.

3. Covered

Covered bonds are issued by credit institutions and collateralized against a pool of assets. In the event of the issuer’s default, these assets will be liquidated, and proceeds will be used to pay the amount due to investors.

4. Convertible

Convertible bonds give the bondholders the option to convert their bonds into equities (companies’ shares). These bonds are especially useful for companies with good growth potential. If the price of the company’s share rises a lot, investors convert their bonds into shares and make a profit.

5. Inflation-Linked

Inflation-Linked bonds are issued by a government and protect the bondholder against inflation. To do so the coupon is linked to a Consumer Price Index (CPI) and varies in accordance with it.

6. Mortgage-Backed Securities

Mortgage-Backed Securities (MBS) are asset-backed securities collateralized by one or several mortgages. The cash flow mechanisms are similar to bonds. The issuer buys mortgages and pools them to create a new financial product, MBS. The issuer pays MBS investors with the repayments it receives from pooled mortgages.

7. Credit Default Swap

Credit Default Swaps (CDS) are not fixed-income securities but derivative products. They work as insurance contracts, protecting the bondholder against the event that the issuer defaults. In this situation, CDS holders are paid back by the swap provider. Since the price of a CDS is directly linked to the credit risk of the issuer it covers, it is possible to earn a profit if the issuer’s credit quality changes. Funds classified as CDS expose the investor to the credit risk of the bond issuers.

8. Overnight Rate

Overnight rates are interest rates at which a major bank will lend to or borrow from another major bank in the very short term (1 day). Some funds seek to replicate or outperform this rate.

9. Multiple Types

Funds that comprise different types of bonds.