Carty & Company, Inc.
What Are Corporate Bonds?
Corporate bonds (also called “corporates”) are debt obligations, or IOUs, issued by privately and publicly owned corporations. When you buy a corporate bond, you essentially lend money to the entity that issued it. In return for the loan of your funds, the issuer agrees to pay you interest and to return the original loan amount – the face value or principal – when the bond matures or is called (the “maturity date” or “call date”).
In order to better understand bonds, it helps to compare them to stocks. When you buy a stock or a bond, you are investing in financial security in exchange for a potential return. With stocks, a company sells something called a share, or a part of itself, in exchange for cash. Your return is dependent on how much each individual share of the company is worth, and when you decide to sell your shares. On the other hand, the purchase of a bond is essentially a loan to a company in exchange for the principal payment and interest, regardless of how profitable the company is.
Types of Corporate Bonds
The type of corporate bond is determined by its risk and return. These types include:
- Interest Payment
The duration of a corporate bond refers to how long it takes for the bond to mature. There are three lengths of duration in bonds:
Short-term bonds will mature in three years or less, and have historically been considered the safest because they are held for less time. However, when the Fed raises interest rates like was done in 2015, some of these bonds will depreciate in value.
Rates on medium-term bonds have the potential to increase as the Fed slows down on its purchase of U.S. Treasury Notes. The duration of medium-term bonds is four to ten years and they are purchased primarily when the economy needs to be stimulated.
Long-term bonds have maturity rates of more than 10 years and offer higher interest rates because they are held longer. However, this also means that the overall return on a long-term bond is more sensitive to interest rate movements than on shorter-term bonds. Many long-term bonds allow the issuing company to redeem them after the first decade if the interest rates have dropped.
Risk can be broken down into two categories:
- Investment-grade bonds
- High-yield bonds
These bonds are issued by companies that are less likely to default. Most corporate bonds are considered investment-grade, and they are attractive to investors who want a higher return than you get with Treasury Notes.
High-yield bonds will often offer the highest return but are considered the riskiest of corporate bonds.
There are four types of interest payments in relation to corporate bonds:
- Fixed-rate bonds
- Floating-rate bonds
- Zero-coupon bonds
- Convertible bonds
Also called plain vanilla, these corporate bonds are the most common. Investors will receive the same payment each month until the bond is matured.
Payments on floating-rate bonds will reset every six months based on the prevailing interest rates of the Treasury.
These bonds withhold interest payments until the bond reaches maturity. However, the investor is required to pay taxes on the accrued value as if they were being paid.
Convertible bonds work like fixed-rate bonds but offer lower interest rates because of added advantages. An investor can convert these bonds to shares of stock, and if stock prices rise, the value of the bonds will increase.
Corporate bonds range from triple “A” to below investment grade. Investment-grade are bonds rated BBB-/Baa3 or higher. Bonds with lower ratings are considered high yield, or speculative. Credit risk, liquidity risk, and interest rate risk are the main drivers of corporate bond prices.
Why Do Corporations Sell Bonds?
A corporate bond is a kind of debt financing, and as is the case, corporations issue bonds to pay for planned projects. That may be the construction of a new facility, renovations, or the means to hire a team to work on a project. However, it should be noted that in order to offer corporate bonds, a company must be established and have a consistent earning record.
Stock vs. Bond
The major difference between a corporate bond and a stock is that while a stock’s price might fluctuate creating risk for its investors, a bond is paid out as interest. Bonds are much less risky unless the company is in danger of going under. However, even if a company goes bankrupt, it’s obligated to pay its bondholders in full before considering stockholders.
More Information on Bonds
For additional information on corporate bond education and investing in specific bonds:
Carty & Co. Can Help You Learn About Corporate Bonds
As financial experts, Carty & Company has been helping clients all over the United States since 1970. We’re prepared to help you examine your investments and guide you through the process of making the best decisions for your financial health. If you’re considering purchasing corporate bonds, reach out to us and learn more about this and other investment opportunities.