Corporate bonds

Definition

Corporate bonds are debt securities issued by corporations to raise capital for various purposes, such as funding operations, expansions, or refinancing existing debt. Investors who purchase corporate bonds are essentially lending money to the issuing company in exchange for periodic interest payments and the return of the bond's face value upon maturity. These bonds play a crucial role in the bond market by providing companies with a means of financing while offering investors an opportunity to earn fixed income.

5 Must Know Facts For Your Next Test

1. Corporate bonds typically offer higher yields than government bonds due to the increased risk associated with corporate issuers.
2. The credit rating assigned to a corporate bond can significantly impact its pricing and demand in the market, with higher-rated bonds generally being more desirable.
3. Investors in corporate bonds receive regular interest payments, known as coupon payments, which are typically paid semi-annually.
4. Corporate bonds can vary widely in terms of maturity dates, with some bonds maturing in just a few years while others may have terms extending up to 30 years or more.
5. In the event of a corporation's bankruptcy, corporate bondholders may have a higher claim on the company's assets compared to equity shareholders, but they are still at risk of losing their investment.

Review Questions

• How do corporate bonds compare to government bonds in terms of risk and return?
  • Corporate bonds generally carry higher risks compared to government bonds because they depend on the financial health of the issuing corporation. As a result, they typically offer higher yields to compensate investors for this increased risk. While government bonds are considered safer due to backing by the government, corporate bonds can provide greater returns but also expose investors to potential default risk.
• What role do bond ratings play in the pricing and attractiveness of corporate bonds?
  • Bond ratings are crucial because they provide investors with insights into the creditworthiness of corporate issuers. A high bond rating indicates lower risk and typically results in lower yields since investors are willing to accept less return for less risk. Conversely, lower-rated corporate bonds often come with higher yields to attract investors willing to take on additional risk, impacting their pricing and demand in the market.
• Evaluate the significance of corporate bonds in a diversified investment portfolio and how they can influence overall risk exposure.
  • Corporate bonds play a significant role in diversifying an investment portfolio by adding fixed-income securities that can provide stability and regular income. When included alongside equities and other assets, they can help mitigate overall portfolio risk, especially during periods of market volatility. Additionally, the varying credit ratings and maturities of corporate bonds allow investors to tailor their exposure based on their risk tolerance and investment objectives, balancing potential returns with associated risks.

Related terms

Interest Rate:

The amount charged by lenders to borrowers for the use of money, typically expressed as a percentage of the principal.

Bond Rating: An assessment of the creditworthiness of a bond issuer, provided by rating agencies, which influences the interest rate and demand for the bond.

Yield: The return on investment for a bond, usually expressed as an annual percentage of the bond's price, reflecting both interest payments and any capital gains or losses.