Curious about buying corporate bonds and 10 tips to help you get started? Buying a corporate bond does not give you ownership interest in the corporation, it just means that you are lending money to the corporation that issued the bond and in exchange for your purchase you should expect your money back plus interest that will be earned during the time that you own the bond. Here are 10 tips that you should know when buying a corporate bond:
- Do your research into the corporation that is issuing the bond. Check to see how well the business has been doing financially within the last few years and look at the proposals for the upcoming quarter. Also see what departments the business wants to expand in and the estimated market value proposal. The default risk in owning a corporate bond is high because it depends heavily on the market value.
- The default risk on corporate bonds is higher than government bonds. As a result of the market value of the specific business your bond is issued from, the interest rate earned is much higher for the risk being taken. The compensation for buying a corporate bond is well worth the investment and risk at the end of the bond's maturity.
- There are other risks that come along with buying a corporate bond that make the purchase worth the risk. One of the risks is the Credit Spread Risk, which only compensates the investors when the bond’s value and interest rate depreciates, causing the credit spread to be offered as compensation to the buyer. This is a good compensation for some people because it means fewer taxes will be paid out.
- The interest rate risk on a corporate bond tends to fluctuate. The level of interest in a bond market changes as the market value of the business fluctuates, which causes the interest earned at the maturity of the bond to adjust to the market. This adjustment only affects the interest on the bond itself, not the amount you paid for the bond.
- Where you purchase the corporate bond is important for you. You can purchase the bond from any financial institution and, depending on the guidelines of the purchase, you will pay a fee. Of course, you can always purchase your bonds from a bond broker and pay a fee and commission, or through an online trading company, which may have fewer fees involved.
- Determine how long you are willing to wait for the bond. There are short- and long-term bonds; you have to determine which type of bond is best for your needs. Short-term bonds may mature in anywhere from one to three years, which may work out better for you financially. A long-term bond may hinder you financially because of the increased risk of a company takeover, merger or bankruptcy occurring.
- The selling of the bond at maturity is considered a liquidity risk for the initial buyer. The risk value of the bond at the end of maturity is also dependent on the market value of the business. This risk leaves the initial investor with difficulty in selling their bond at even close to what they paid in the beginning.
- The inflation risk that you are taking when buying a corporate bond is always unstable. Inflation reduces the real value of any future fixed cash flow that was anticipated for the bond. The anticipation of inflation should be accounted for when purchasing a corporate bond because the price may decrease immediately after the purchase.
- Corporate bonds have a higher earning yield than government bonds. The corporation is looking to enlarge its business, but the conditions will depend on if the corporation will be able to actually expand. The market that the corporation is in will alter the interest rate on your bond that you purchase.
- If you are looking for a tax break, you won’t find it buying a corporate bond. You must pay taxes on the interest earned while you own the corporate bond. Only government bonds are tax exempt, but you will have a higher interest yield owning a corporate bond.
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