Corporate Bonds

Definition

Corporate bonds are debt securities issued by corporations to raise capital. When an investor buys a corporate bond, they are essentially lending money to the corporation in exchange for periodic interest payments and the return of the bond's face value at maturity. This makes corporate bonds an essential investment vehicle, offering investors a way to earn fixed income while supporting business growth.

5 Must Know Facts For Your Next Test

1. Corporate bonds are classified into two main categories: investment-grade bonds, which have lower risk and higher ratings, and high-yield (or junk) bonds, which offer higher returns but come with greater risk.
2. Interest on corporate bonds is typically paid semi-annually, providing a regular income stream for investors.
3. The duration of corporate bonds can vary widely, with maturities ranging from a few years to several decades, allowing investors to choose bonds that fit their time horizon.
4. Investors should be aware of the potential risks associated with corporate bonds, including credit risk (the chance that the issuer may default) and interest rate risk (the potential for bond prices to fall when interest rates rise).
5. Secondary markets exist for trading corporate bonds, allowing investors to buy and sell these securities before their maturity date, potentially realizing gains or losses based on market conditions.

Review Questions

• How do corporate bonds function as an investment vehicle compared to other types of investments?
  • Corporate bonds function as an investment vehicle by offering fixed income through regular interest payments and the return of principal at maturity. Unlike stocks, which provide ownership in a company and are subject to market fluctuations, corporate bonds are debt obligations with defined terms. This stability makes them attractive for conservative investors seeking steady income, although they do carry risks such as credit and interest rate risk.
• What factors influence the pricing and yield of corporate bonds in the market?
  • The pricing and yield of corporate bonds are influenced by several factors including the issuer's credit rating, prevailing interest rates, and overall market conditions. A higher credit rating usually leads to lower yields since investors perceive less risk. Conversely, if interest rates rise, existing bond prices typically fall, leading to higher yields on new issuances. Economic conditions and investor sentiment can also impact demand for corporate bonds, thus affecting their prices.
• Evaluate how changes in interest rates can affect the attractiveness of corporate bonds as an investment option.
  • Changes in interest rates have a significant impact on the attractiveness of corporate bonds. When interest rates rise, newly issued bonds typically offer higher yields compared to existing ones, making existing bonds less attractive. Investors may then seek out new issues instead. Conversely, when interest rates fall, existing corporate bonds with higher fixed rates become more valuable. This dynamic creates volatility in bond prices and influences investor decisions based on their expectations of future interest rate movements.

Related terms

Bond Rating: A bond rating is an evaluation of the creditworthiness of a bond issuer, indicating the likelihood that the issuer will default on its debt obligations.

Yield to Maturity:

Yield to maturity is the total return anticipated on a bond if it is held until it matures, taking into account both interest payments and any capital gains or losses.

Convertible Bonds: Convertible bonds are corporate bonds that can be converted into a predetermined number of the company's shares at certain times during their life.