Corporate Bonds

 What are corporate bonds?

Corporate bonds are issued by corporations and usually mature within 1 to 30 years. These bonds usually offer a higher yield than government bonds but carry more risk. Corporate bonds can be categorized into groups, depending on the market sector the company operates in. They can also be differentiated based on the security backing the bond or the lack of security.

Summary Points

1. Corporate bonds are issued by corporations and usually distributed by a trustee such as a bank
2. Corporate bonds are split into five categories: public utilities, transportation, industrials, banks and finance companies, and international issues
3. Bonds can be backed by a variety of assets, such as mortgages, equipment, or other companies.

A bond is a debt obligation, like an IOU. Investors who buy corporate bonds are lending money to the company issuing the bond. In return, the company makes a legal commitment to pay interest on the principal and, in most cases, to return the principal when the bond comes due, or matures.

To understand bonds, it is helpful to compare them with stocks. When you buy a share of common stock, you own equity in the company and will receive any dividends declared and paid by the company. When you buy a corporate bond, you do not own equity in the company. You will receive only the interest and principal on the bond, no matter how profitable the company becomes or how high its stock price climbs. But if the company runs into financial difficulties, it still has a legal obligation to make timely payments of interest and principal. The company has no similar obligation to pay dividends to shareholders. In a bankruptcy, bond investors have priority over shareholders in claims on the company's assets.

Like all investments, bonds carry risks. One key risk to a bondholder is that the company may fail to make timely payments of interest or principal. If that happens, the company will default on its bonds. This "default risk" makes the creditworthiness of the company—that is, its ability to pay its debt obligations on time—an important concern to bondholders.

Corporate Bond Example;

You purchase a bond with a 5% coupon rate from Company XYZ. The bond has a face value of $1,000. This means you will receive $50 in interest payments per year ($1,000 x 0.05). 

Since corporate issuers usually make payments in six-month installments, you might receive $25 in January and the other $25 in June. 

For information about the payment schedule, be sure to check the prospectus, indenture agreement, and bond certificate for disclosures. 

Are Corporate Bonds Safe?

In the grand scheme of investment choices, corporate bonds are relatively safe, liquid investments. This depends, however, on several factors like the investor's tolerance for risk and their investment horizon.

Corporate bonds aren’t generally safer than government bonds, certificates of deposit, or most municipal bonds. That’s because corporations are more likely to default on their obligations than the US government, local governments, and banks. This added risk means that corporate bonds typically offer higher returns than these instruments.