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Bond Financing - What Is A Corporate Bond?

A corporate bond is a type of debt security that is issued by a firm and sold to investors. The company gets the capital it needs, and in return, the investor is paid a pre-established number of interest payments at either a fixed or variable interest rate. When the bond expires or reaches maturity, the payments cease, and the original investment is returned.

The bond’s backing is generally the company’s ability to repay, which depends on its future revenues and profitability prospects. In some cases, the company’s physical assets may be used as collateral.

Understanding Corporate Bonds

High-quality corporate bonds are considered a relatively safe and conservative investment in the investment hierarchy. Investors building balanced portfolios often add bonds to offset riskier investments such as growth stocks. Over a lifetime, these investors tend to add more bonds and fewer risky investments to safeguard their accumulated capital. Retirees often invest more of their assets in bonds to establish a reliable income supplement.

Corporate bonds are generally considered to have a higher risk than U.S. government bonds. As a result, corporate bonds’ interest rates are almost always higher, even for companies with top-flight credit quality. The difference between the yields on highly-rated corporate bonds and U.S. Treasuries is called the credit spread.

Corporate Bond Ratings

Before being issued to investors, bonds are reviewed for the issuer’s creditworthiness by one or more of three U.S. rating agencies: Standard & Poor’s Global Ratings, Moody’s Investor Services, and Fitch Ratings. Each has its own ranking system, but the highest-rated bonds are called Triple-A-rated bonds. The lowest-rated corporate bonds are called high-yield bonds due to their more significant interest rate applied to compensate for their higher risk. These are also known as junk bonds.

Bond ratings are vital to alerting investors to the quality and stability of the bond in question. These ratings consequently greatly influence interest rates, investment appetite, and bond pricing.

How Corporate Bonds Are Sold

Corporate bonds are issued in blocks of $1,000 in face or par value. Almost all have a standard coupon payment structure. Typically a corporate issuer will enlist the help of an investment bank to underwrite and market the bond offering to investors.

The investor receives regular interest payments from the issuer until the bond matures. At that point, the investor reclaims the face value of the bond. The bonds may have a fixed interest rate or a rate that floats according to the movements of a particular economic indicator.

Corporate bonds sometimes have call provisions to allow for early prepayment if prevailing interest rates change so dramatically that the company deems it can do better by issuing a new bond.

Investors may also opt to sell bonds before they mature. If a bond is sold, the owner gets less than face value. The amount it is worth is determined primarily by the number of payments still due before the bond matures.

Investors may also gain access to corporate bonds by investing in any number of bond-focused mutual funds or ETFs.

Why Do Corporations Sell Bonds?

Corporate bonds are a form of debt financing. They are a significant source of capital for many businesses, along with equity, bank loans, and lines of credit. They often are issued to provide the ready cash for a particular project the company wants to undertake. Debt financing is sometimes preferable to issuing stock rather than equity financing because it is typically cheaper for the borrowing firm and does not entail giving up any ownership stake or control in the company.

Generally speaking, a company needs to have consistent earnings potential to be able to offer debt securities to the public at a favorable coupon rate. If a company’s perceived credit quality is higher, it can issue more debt at lower rates.

When a corporation needs a very short-term capital boost, it may sell commercial paper, which is similar to a bond but typically matures in 270 days or less.

The Difference Between Corporate Bonds and Stocks

An investor who buys a corporate bond is lending money to the company. An investor who buys stock is purchasing an ownership share of the company.

The value of a stock rises and falls, and the investor’s stake rises or falls with it. The investor may make money by selling the stock when it reaches a higher price, collecting dividends the company pays, or both.

Investing in bonds makes an investor pay interest rather than profits. The original investment can only be at risk if the company collapses. One crucial difference is that even a bankrupt company must pay its bondholders and other creditors first. Stock owners may be reimbursed for their losses after all those debts are paid in full.

Companies may also issue convertible bonds, which can be turned into company shares if certain conditions are met.

Key Points

  • A corporate bond is debt issued by a company in order for it to raise capital.
  • An investor who buys a corporate bond is effectively lending money to the company in return for a series of interest payments, but these bonds may also actively trade on the secondary market.
  • Corporate bonds are typically seen as somewhat riskier than U.S. government bonds, so they usually have higher interest rates to compensate for this additional risk.
  • The highest quality and safest, lower yielding bonds are commonly referred to as Triple-A bonds, while the least creditworthy are termed junk.
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    About the author

    Dallin Hawkins brings over two decades of expertise within the finance sector, holding executive positions and distinguished as a top performer since 2003. Throughout his tenure, he has orchestrated and structured in excess of $60 billion in volume across diverse industries, including renewable energy, construction, transportation, manufacturing, mining, drilling, and oil and gas sectors. His adept negotiation skills and profound industry acumen have facilitated the successful management and funding of numerous intricate transactions. Leveraging foundational financing principles, Dallin consistently engineers structured and holistic funding solutions. His proficiency spans financial structuring, information technology, marketing, networking, and sales, underpinning his capacity to navigate multifaceted challenges with finesse. Moreover, Dallin's leadership extends beyond transactions, having personally mentored and overseen the development of countless sales executives. His guidance encompasses deal negotiation strategies, adept management of client expectations, and effective time management techniques tailored to the nuances of the finance domain. Notably, Dallin's recent financial venture stands poised to redefine and fortify the financial landscape through unparalleled growth trajectories.

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