What Is A Corporate Bond?

As an investor, it is important to be familiar with all of your investment choices, which is why you should know what is a corporate bond. While the equity or stock market gets most of the mainstream media press, the bond market (especially the corporate bond market) is just as important.

Corporate bonds are investments in a specific company which provides returns to investors. When a company wants to raise money, it has several options. Two of the mainstream options are issuing corporate bonds or stock. Corporate bonds are bought by investors, like you, looking for a return on investment.

Corporate bonds are issued over many terms, the most common being 30 years. Corporate bonds are issued at a “face value,” typically $1000. An investor who buys the bond at first issue will pay face value of the bond, receives regular interest payments (typically every six months) at a stated interest rate, and then receives the face value--$1000--when the bond matures after 30 years. However, during the 30 year term of the bond, the bond can be traded among other investors like you.

Once issued, corporate bonds are traded in the bond market much like stock is traded in the equity market. The price of a bond fluctuates according to many factors, the most important of which include the underlying financial/operational health of the issuing company and demand for those corporate bonds. Many investors treat corporate bonds just like stock, hoping to buy low and sell high as their value increases.

In addition to the underlying value of a corporate bond, investors receive interest payments. Usually every six months, investors will get payments equal to the interest rate of the corporate bond. These interest payments can be a regular income stream for those interested in income-producing investments. The interest rate is determined when a bond is first issued by a company and does not change during the life of the bond. The only thing that changes is the price of the bond.

When investing in corporate bonds, there are a few characteristics of bonds that all investors must know. First is the corporate bond rating. Rating agencies like Moody’s or Standard & Poor’s, rate every bond at the time of issue. Ratings are determined by the financial health of the company and give a good estimate as to the riskiness of the bond. Highly-rated bonds can be expected to make their interest payments on time every time with little risk of default. Lower rated bonds, also called junk bonds, carry much more risk that the company will not be able to make their interest payments and they will default (often forcing the company into bankruptcy). The ratings help determine the interest rate the company pays through the life of the bond and which is set at the time of issue.

Periodically, through the life of the corporate bonds, the rating agencies can alter their rating either upward or downward. These changes in rating can have a significant impact on the value of the bond when traded.

A second characteristic of bonds all investors should be aware of is liquidity. Most stock can be traded on an exchange whenever an investor feels like it. However, certain bonds are harder or easier to trade depending on the demand for the bonds of a specific company. Investors should research to see if bonds they are interested in trade regularly so they can get out of the investment if they wish.

Corporate bonds are another tool in every investor’s toolbox. Some highly-rated corporate bonds are safe, secure investments that carry little risk and provide regular income in the form of interest payments. Other corporate bonds are very risky, with a high rate of default, but carry a higher interest rate to compensate.

References:

Bonds, Corporate