What are Corporate Bonds?

A corporate bond is a way for investors to loan money to companies. A company will pay interest to bondholders regularly over a set period of time. When the bond matures, the company will repay the bondholder the full-face value of the bond. Corporate bonds are similar to government bonds in structure, but tend to offer higher coupon payments because are usually considered higher risk than a bond issued by the US Government.   

The bond itself is usually secured either by the company’s revenue or their assets. For example, a well-established company with a proven ability to bring in a steady revenue stream can offer attractive bond coupons and a measure of security to investors compared to a brand-new company with an unproven ability to earn money. 

Corporate Bonds versus Stocks

Corporate bonds and stocks are both used as a way for a company to raise capital. But stocks represent equity in the company, or ownership. This means if the value of the company rises or falls dramatically, so will the value of your asset. Stocks may offer a dividend, but are not required to.

A corporate bond, on the other hand, usually has a more stable value having less to do with how well the asset is performing and more to do with the demand for bonds. If all goes well, the bondholder will earn a constant return on their investment, even if the company’s stock triples in value. If all does not go well and the company goes bankrupt, bondholders have some protections under bankruptcy law and have a legal claim to be paid. However, this can take time and bond holders do not always get all of their investment back.

Corporate bonds are often used as a more predictable and stable balance to more volatile assets like stocks.

Bond Maturity and Rating

Corporate bonds offer interest payments for a set length of time, such as one year, five years, or ten years. After that period, the initial investment will be returned in addition to the last interest payment. In some cases, investors can redeem or sell their bonds early.

Often investors are not directly purchasing bonds, but investing in bond-based mutual funds. These investments may offer a steady dividend in the form of interest payments and fluctuate in value based the current interest rates. A fund of many different bonds lowers the chance of losing money even further by spreading out the expectation of return.

Another way that corporate bonds differ from one another is in how the bond is rated. Credit agencies calculate the chances that a bond will be defaulted on and assign a corresponding rating. An investment-grade bond has a lower chance of going into default, while lower rated bonds usually have a higher chance.

 The highest bond rating is AAA, which is considered prime investment grade bond. High grade (but not prime) investment bonds are those with ratings of AA+, AA, and AA-. Medium grade bonds rate at A+, A, and A-. The ratings continue through B, C, and D in the same manner, creating 20 different total ratings.

Bankruptcy

There are special rules about what happens to bonds when a company files bankruptcy. Bondholders, like all of the company’s other creditors, will have a chance to file a claim in the proceedings. Many bonds list in the terms exactly where a bondholder’s claim will sit if the company ever were to file bankruptcy, and this order of priority will also depend on the type of bond. If a bond were secured by company owned property, such as equipment or real estate, the bondholders could pursue seizing those assets.

These features of a bond offer some measure of security against losing money on your investment.

Corporate Bonds

Any company can offer bonds, whether or not they have a solid business plan and leadership. Like any other asset, it is important to perform due diligence before purchasing bonds. However, bonds are usually not as volatile as stocks and offer regular interest payments.