What is a Taxable Bond?
A taxable bond is a bond whose interest payments are taxable at the federal, state and/or local level.
How Does a Taxable Bond Work?
The purchaser of a taxable bond is, in effect, lending money to a company or other entity that will make a predetermined number of interest and principal payments to the purchaser. Issuers typically use bond proceeds to finance day-to-day operating activities or capital expenditures. The interest rate on taxable bonds can be fixed or variable.
There are many kinds of taxable bonds, and they may be purchased directly from the issuer at the time of issuance or (much more often) in the secondary market through a broker/dealer. One of the most popular ways to invest in bonds is by purchasing shares of a bond fund, which invests in a variety of funds within a certain sector or with a given characteristic.
Ratings agencies often evaluate and rate the creditworthiness of bonds and their issuers. These ratings affect the price of the bonds on the secondary market.
A taxable bond often has a lower yield than a municipal bond with the same coupon rate (because the interest from municipal bonds is usually not taxable). For this reason, municipal-bond yields are frequently articulated in terms of the taxable interest rate equivalent to similar corporate-bond rates. (To learn how to determine the equivalent taxable interest rate for municipal bonds and taxable bonds, see our municipal bond entry.)
Why Does a Taxable Bond Matter?
The interest from most bonds is taxable. Thus, investors need to consider their own tax situations when investing, and they need to factor taxes into their return calculations. Additionally, as with all debt, bond investors are subject to credit, interest-rate, call and market risk.
