Bonds are IOUs that are made up of

a)  Principal:  is the money you lend to an entity against the IOU, and

b)  Interest:  is the interest paid to you on the principal you lent. This is also called the coupon.

Thus, bonds are debt instruments where the bond issuer is indebted to the bond holder who lent money against the bond or the IOU.

Bonds are issued by a government or a corporation.

Government Bonds:  Government bonds are either issued by municipalities or by the United States Department of Treasury.

a)  Municipal Bonds:  these are bonds issued by municipalities to finance public works projects in that particular municipality. The municipalities hope to recoup the expense by charging a fee, or municipal tax, to its residents since they will benefit as a result of the project. The municipalities pay interest on the money you have lent against the bond. These bonds are also called Munis, and the interest income from them is generally tax free.

b)  US Treasuries:  there are two types of debt instruments issued by the US Department of Treasury, short term treasury bills or T-Bills and long term treasury bonds or T-Bonds. T-Bills are of maturities less than a year, and T-Bonds have maturities of more than 10 years. Interest income from T-Bills or T-Bonds are generally taxable at your marginal tax rate, and thus, unlike Munis, provide no tax advantages.

Corporate Bonds:  these are debt instruments issued by corporations, and could be of any length of time or maturity. Corporate bonds, just like government bonds, consist of the principal and interest payments. One additional aspect of a corporate bond could be that it could be a “convertible” bond, where the bondholder has the option to convert the bonds into a pre-determined ratio of shares of the corporation for every bond that the bondholder holds. Interest income from corporate bonds is taxable at your marginal tax rate, and thus provide no tax advantages.

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