Bonds are issued by five broad types of entities: the U.S. federal government, state and local governments, corporations, government-sponsored enterprises and federal agencies, and international or supranational organizations. Each bond is a loan from you to the issuer, who promises to repay the principal on a set date and usually pays interest along the way. Who issues a bond shapes almost everything else about it: how likely you are to be repaid, whether the interest is taxable, and what legal protections you have if something goes wrong.
The U.S. Federal Government
The U.S. Department of the Treasury is the single largest bond issuer in the world. It borrows on behalf of the federal government to cover the gap between tax revenue and spending, within a statutory debt ceiling set by Congress under 31 U.S.C. § 3101.1Office of the Law Revision Counsel. 31 USC 3101 – Public Debt Limit The Treasury raises that money by selling securities at regular public auctions.2U.S. Department of the Treasury. Financing the Government
Marketable Treasury securities come in three main forms based on how long your money is tied up:
- Treasury bills mature in 4 to 52 weeks. They are sold at a discount and pay no periodic interest; you receive the full face value at maturity.
- Treasury notes mature in 2, 3, 5, 7, or 10 years and pay interest every six months.
- Treasury bonds are issued in 20-year and 30-year terms and also pay interest every six months.
The Treasury also issues inflation-protected securities (TIPS), whose principal adjusts with the Consumer Price Index.3TreasuryDirect. About Treasury Marketable Securities
Savings Bonds
The Treasury sells savings bonds directly to individual investors through TreasuryDirect.gov. Series EE bonds pay a fixed rate; Series I bonds pay a rate that adjusts with inflation. You can buy up to $10,000 in electronic EE bonds and $10,000 in electronic I bonds per Social Security Number each calendar year.4TreasuryDirect. How Much Can I Spend/Own? Savings bonds cannot be resold to other investors. You redeem them with the government.
State and Local Governments
States, counties, cities, school districts, water authorities, and other local entities issue bonds — collectively called municipal bonds — to pay for roads, schools, hospitals, water systems, and other public infrastructure. Their borrowing authority comes from state constitutions and statutes, which typically cap debt as a percentage of assessed property value in the jurisdiction. Many types of municipal borrowing require voter approval.
Municipal bonds fall into two broad categories. General obligation bonds are backed by the issuer’s full taxing power, so if revenue falls short, the local government can raise taxes to cover the payments. Revenue bonds are repaid only from the income of a specific project, such as highway tolls, water fees, or airport charges. If the project underperforms, bondholders bear that risk; the issuer’s general tax revenue is not pledged.
Under 26 U.S.C. § 103, interest earned on bonds issued by a state or local government is generally excluded from your gross income for federal income tax purposes.5Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds Most states also exempt interest on bonds issued within their own borders from state income tax. When a bond is exempt from federal, state, and local income taxes, investors call it triple tax-exempt. That advantage lets municipal issuers borrow at lower interest rates than corporations, because investors accept a lower return when they owe no tax on the income.
There are exceptions. Private activity bonds, where the proceeds benefit a private entity rather than the general public, are typically taxable unless they qualify under specific provisions of the Internal Revenue Code. Arbitrage bonds, where the issuer reinvests borrowed funds at a higher rate, also lose their tax-exempt status.5Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds
Corporations
Publicly traded companies and large private firms issue bonds to raise capital without giving up ownership through stock sales. Corporate bonds generally pay higher interest than government bonds because they carry more risk: the company could run into financial trouble and miss payments.
Federal securities law requires that a corporation selling bonds to the public first file a registration statement with the Securities and Exchange Commission. Under 15 U.S.C. § 77e, it is unlawful to sell a security without an effective registration statement, and the issuer must give investors a prospectus disclosing its financial condition, the terms of the offering, and the risks involved.6Office of the Law Revision Counsel. 15 USC 77e – Prohibitions Relating to Interstate Commerce and the Mails7Office of the Law Revision Counsel. 15 USC 77f – Registration of Securities
Trustee Protection for Bondholders
When a corporation sells bonds to the public, the Trust Indenture Act of 1939 generally requires a formal agreement between the issuer and an independent trustee who represents the bondholders. The trustee monitors whether the issuer keeps its promises and acts on behalf of bondholders if problems arise. If the issuer defaults, the trustee must exercise its powers with the same care a reasonable person would use managing their own affairs.8Office of the Law Revision Counsel. 15 USC 77ooo – Duties and Responsibility of the Trustee Smaller bond offerings, generally those under $10 million in aggregate principal, are exempt from this requirement.9Office of the Law Revision Counsel. 15 USC 77ddd – Exempted Securities and Transactions
Seniority and Repayment Priority
Not all corporate bonds from the same company carry the same risk. In bankruptcy, creditors are paid in a set legal order. Secured bondholders, whose bonds are backed by specific assets like property or equipment, are paid first from the value of that collateral. Unsecured senior bondholders come next, then subordinated bondholders. Common stockholders are last and often receive nothing. Federal bankruptcy law sets out this hierarchy in detail.10Office of the Law Revision Counsel. 11 USC 507 – Priorities
Because of this order, secured bonds typically pay lower rates than unsecured bonds, and senior bonds pay less than subordinated ones. A debenture, which is an unsecured bond backed only by the company’s general creditworthiness, carries more risk than a secured bond from the same issuer, and the interest rate reflects that.
Government-Sponsored Enterprises and Federal Agencies
Government-Sponsored Enterprises (GSEs) are privately owned corporations Congress created to serve specific public purposes, most prominently in housing finance. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) buy mortgages from lenders and either hold them or package them into mortgage-backed securities.
Fannie Mae’s authority to issue debt comes from its federal charter under 12 U.S.C. § 1719, which allows it to issue bonds with the approval of the Secretary of the Treasury.11Office of the Law Revision Counsel. 12 USC 1719 – Secondary Market Operations That statute requires every GSE bond to carry language stating it is not guaranteed by the United States and is not a federal debt obligation. In practice, though, the federal government placed both Fannie Mae and Freddie Mac into conservatorship in 2008, and investors widely treat their bonds as carrying an implicit government backing. The Federal Housing Finance Agency oversees both entities under the Federal Housing Enterprises Financial Safety and Soundness Act.12Office of the Law Revision Counsel. 12 USC Chapter 46, Subchapter I, Part A – Financial Safety and Soundness Regulator
Federal agencies also issue debt directly, and these bonds often carry a stronger guarantee. The Small Business Administration, for example, is authorized to issue trust certificates backed by pools of guaranteed small business loans, and those certificates carry the full faith and credit of the United States.13Office of the Law Revision Counsel. 15 USC 697b – Pooling of Debentures That explicit backing distinguishes agency bonds from GSE bonds and generally means agency bonds pay lower interest.
International and Supranational Issuers
Supranational organizations, formed by multiple countries through international agreements, issue bonds to fund global development. The International Bank for Reconstruction and Development, commonly called the World Bank, is one of the largest international borrowers and has issued bonds since 1947.14World Bank Treasury. Issues – World Bank Treasury World Bank bonds are not direct obligations of any single government; they are collectively backed by the capital commitments of its 189 sovereign member countries.15World Bank Treasury. Debt Products FAQs
Foreign national governments also issue sovereign bonds in global markets. When a foreign government sells bonds in the United States, enforcement can get complicated. The Foreign Sovereign Immunities Act generally prevents U.S. courts from exercising jurisdiction over foreign governments, but it carves out an exception for commercial activities, which can include bond issuances.16Office of the Law Revision Counsel. 28 USC 1602 – Findings and Declaration of Purpose You also face currency risk on foreign sovereign bonds: if the bond pays interest in a foreign currency that weakens against the dollar, your returns shrink even if the issuer makes every payment on time.
How the Issuer Affects Your Taxes
Interest on U.S. Treasury securities is subject to federal income tax but exempt from all state and local income taxes.17Internal Revenue Service. Topic No. 403, Interest Received Interest on most municipal bonds is exempt from federal income tax under 26 U.S.C. § 103, and usually exempt from state tax if you live in the state that issued the bond.5Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds Corporate bond interest is fully taxable at both the federal and state level, and you must report all taxable interest on your federal return, even if you don’t receive a Form 1099-INT. These differences are why comparing yields across issuer types requires looking at after-tax returns, not just the stated interest rate.
How the Issuer Affects Default Risk
The risk that an issuer will fail to pay varies sharply by category. U.S. Treasury bonds are considered virtually risk-free because they are backed by the federal government’s taxing power. Municipal bonds historically default at very low rates, roughly 0.08% over a five-year horizon, compared with global corporate bonds at closer to 7% over the same timeframe. The gap widens at lower ratings: speculative-grade municipal bonds default at roughly one-fifth the rate of speculative-grade corporate bonds.
Credit rating agencies assign letter grades to help investors compare risk. Ratings from Aaa/AAA down through Baa/BBB are investment grade, meaning the issuer has a relatively low risk of default. Bonds rated Ba/BB and lower are speculative grade, sometimes called high yield, and carry meaningfully higher risk. A lower-rated issuer must pay more interest to attract buyers willing to take that risk.
Ratings are not guarantees. A bond’s rating can change at any time if the issuer’s financial condition improves or deteriorates. If you buy individual bonds rather than a diversified bond fund, pay close attention to the issuer’s credit quality, and remember that higher yields come with a real possibility of missed payments or loss of principal.