A bond is a debt security, similar to an I.O.U (I Owe yoU) .When you purchase a bond; you are lending money to the issuer which may be a government, municipality, corporation, federal agency, corporate or other entity. In return for the loan, the issuer promises to pay you a specified rate of interest during the life of the bond and to pay back the face value of the bond or the principal when it “matures,” or comes due.
Among the types of bonds you can choose from are: government securities, municipal bonds, corporate bonds, mortgage and asset—backed securities and foreign government bonds.

Types of Bonds

Zero coupon bonds do not pay any interest. They are issued at a substantial discount to par value. The bond holder receives the full principal amount on the redemption date. Zero coupon bonds may be created from fixed rate bonds by a financial institutions separating "stripping off" the coupons from the principal. In other words, the separated coupons and the final principal payment of the bond are allowed to trade independently.

Government Securities is a bond where government is the issuer or borrower. It is the safest form of bond as it is extremely unlikely that the government defaults (unless the economy is as bad as that of Pakistan). Government issues bonds to raise money for funding infrastructure development, support subsidies or several other initiatives. For example government of India has recently started issuing fertilizer and oil bonds to Public Sector companies to fund subsidies on fertilizers and oils.

Municipal Bond is a bond issued by a state, local government, or their agencies. Interest income received by holders of municipal bonds is often exempt from the income tax and from the income tax of the state in which they are issued, although municipal bonds issued for certain purposes may not be tax exempt.

Corporate Bond is a bond issued by corporate i.e. public or private companies to the investors. The company borrows money from investors and promise to pay interest at regular interval. The interest rates on such bonds are high compared to government bonds because the probability of government defaulting on interest payments is low compared to that of corporate. Hence, corporate bonds have high risk and hence require higher return.

High Yield Bonds are those bonds that are rated below investment grade (lower than BBB-) by the credit rating agencies. I will talk in details about rating agencies and bond rating. As these bonds are more risky than investment grade bonds, investors usually expect to earn a higher yield. These bonds are also known as Junk Bonds.

Inflation linked bonds are bonds where the principal amount and interest payments are indexed to inflation. The interest rate is usually lower than that of fixed rate bonds with a comparable maturity. Though, as the principal amount grows, the payments increase with inflation. The government of the United Kingdom was the first to issue inflation linked bonds in the 1980s. Treasury Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation linked bonds issued by the U.S. government.

Subordinated Bonds are those that have a lower priority than other bonds of the issuer in case of liquidation/winding up. In case of bankruptcy, there is a hierarchy of creditors. First and foremost the liquidator is paid, then government taxes, etc. The first bond holders in line to be paid are those holding what is called senior bonds. After these senior bonds have been paid, the subordinated bond holders are paid. As a result, the risk is higher. Thus, subordinated bonds generally have a lower credit rating than senior bonds. The main examples of subordinated bonds can be found in bonds issued by banks, and asset-backed securities. The latter are often issued in tranches. The senior tranches get paid back first; the subordinated tranches are paid later.

Perpetual Bonds are generally called perpetuities. They have no maturity date.

Bearer Bond is an official certificate issued without a named holder. In other words, the person who has the paper certificate that is the bearer can claim the value of the bond. Usually they are registered by a number to prevent counterfeiting, but may be traded like cash. Bearer bonds are very risk prone because they can be lost or stolen.

Registered Bond is a bond whose ownership and any subsequent purchaser are recorded by the issuer, or by a transfer agent. It is the alternative to a Bearer bond. Interest payments, and the principal upon maturity, are sent to the registered owner only.