What Is A Corporate Bond?
A corporate bond is a debt security issued by a company to finance business operations or expansion. When an investor buys a bond, they are essentially lending money to the issuer in exchange for interest payments at fixed intervals until the bond matures. Once it reaches maturity, the issuer repays the face value (also known as par value) of the bond to the investor.
Different Types of Corporate Bonds:
- Investment-Grade vs. High-Yield: Investment-grade bonds have a higher credit rating than high-yield (also known as junk) bonds because they pose less risk of default for investors.
- Callable vs. Non-Callable: Callable bonds allow issuers to call back their debt earlier than maturity if interest rates drop significantly.
- Convertible vs. Non-Convertible: Convertible bonds give investors the option to convert their debt into equity under certain conditions.
Buying and Selling Bonds
There are different ways you can buy and sell corporate bonds depending on whether you prefer doing it yourself or relying on professional services:
- Brokerage Accounts: Many online brokerages offer access to secondary markets where individual investors can buy and sell existing corporate bond issues available from inventory.
- Exchange-Traded Funds (ETFs): This is a convenient way for individuals with limited capital looking for exposure across multiple holdings and maturities.
- Mutual Funds: This refers to individuals pooling money together into equities managed by experienced professionals to navigate risks and use proprietary trading tools for maximized returns.
Key Characteristics of Bonds
Before buying any corporate bond, you should consider some key characteristics that will affect its performance:
- Credit Rating: Bond rating agencies (like Moody’s or Standard & Poor’s) issue assessments of risk posed by possible defaulting on repayments which affects probability in terms of frequency and potential severity/value lost.
- Interest Rate: The higher the coupon rate (or interest payment), the more income for investors from each payment made.
- Maturity Date: Maturities that range from a few months to several years can seriously affect yield expectations, however one has to be mindful that the longer the time horizon invested in bonds, there is a greater exposure period to credit/issuer risks.
FAQ
Q: What is a corporate bond?
A: A company issues bonds as a way of raising funds. They borrow from investors in the form of bonds, making it a form of debt. When you purchase a bond, the issuer is legally obliged to pay you regular interest and at the bond’s maturity, pay back the face value of the bond to you.
Q: How do corporate bonds work?
A: When you purchase a bond, the issuer is legally obliged to pay you regular interest (referred to as coupons) and at the bond’s maturity, the face value of the bond (which is the price the bond was issued at – usually $100) must be paid back to you.
Q: Will I get my money back?
A: A bond issuer has a legal obligation to pay back the face of the bond at its maturity. Provided the bond issuer remains solvent, you will be paid the face value of the bond when it matures.
Default rate for bonds that have an investment grade credit rating is just over 1% over a five year term until maturity.
Q: Corporate Bonds are for fixed terms – what happens if I want to sell before the term ends?
A: If you want to sell your bond before its maturity date, you can sell it in the Over The Counter market via a bond broker.
Q: How are corporate bonds different to term deposits
A: There are two main differences between corporate bonds and term deposits. Firstly, term deposits are only issued by banks and other financial institutions, whilst corporate bonds are issued by a more diverse range of companies across different sectors including retail, technology, transport and infrastructure. Secondly, term deposits must be held until they mature, whilst corporate bonds can be bought and sold when it suits you any time prior to maturity.
Q: How are corporate bonds different to shares?
A: When you purchase shares in a company, you become a part owner of that company and there’s no certainty of income via dividends. With corporate bonds, you lend money to the company that issues the bond and it is legally required to pay you regular interest and repay the face value of the bond when the bond matures. This means that investing in a company’s bond is a lower risk than owning its equity or shares.
Another major difference between shares and bonds is that shares are generally traded on an open exchange such as the New York Stock Exchange, whereas the majority of corporate bonds are traded on the OTC market.
The Bottom Line
Investing in corporate bonds can offer attractive returns, but like everything else this comes with trade-offs. These trade-offs might include understanding various terms involved and picking out quality issues over bad performers.
With all these factors considered though, opportunities do exist even for newer investors looking for relatively safer ways of allocating capital while generating regular streams of income within their financial planning strategies.
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