What Are Corporate Bonds?

Corporate bonds are debt securities that are issued by companies for capital raising purposes, where investors are promised a floating/fixed interest rate along with principal repayment at maturity. However, they do not get any ownership in the entity. To put it simply, corporate bonds are essentially a type of debt, where the company issuing these bonds borrows capital from various investors. These bonds are usually issued for financing operation expansion, new projects, or even repaying current debts and liabilities. 

Key Features of Corporate Bonds

Here are some of the key features of corporate bonds - 

• Bonds may have fixed (coupon) interest rates or floating rates which are adjusted depending on any benchmark interest rate
• They come with a specific maturity date
• Bonds have credit ratings given by leading agencies like S&P (Standard & Poor’s), Fitch, Moody’s, etc. which evaluate the issuing company’s creditworthiness and the bonds. These ratings indicate whether the bonds are creditworthy enough for investments or whether there is a likelihood of defaults. 

Why Invest in Corporate Bonds?

Investing in corporate bonds can unlock several advantages, including the following: 

• Portfolio Diversification
  You can invest in multiple economic segments and industries through these bonds, helping you diversify your portfolio and spread out risks accordingly. 
• Income Opportunities
  Many corporate bonds can help you earn attractive income in the long run, with most paying on a semi-annual and fixed schedule. Higher yields in a low-interest rate scenario could be a good opportunity for you. The yields are also affected by factors like the coupon rate, credit risk of the issuing company, and present market prices. Floating-rate bonds have fluctuating rates of interest that are linked to any reference/benchmark rate. Although they have lower yields than fixed-rate securities at times, they may still be value-additions to your portfolio. 

• Liquidity and Higher Returns
  Corporate bonds may sometimes offer higher returns in comparison to Government bonds and many other financial instruments. At the same time, they usually have high liquidity since you can sell them any time before maturity in an active secondary market. 

Types of Corporate Bonds 

To know how corporate bonds work, it’s important to learn about their various types. These include: 

• Secured Bonds- They are backed by particular assets of the company issuing them. 
• Unsecured Bonds- They are not backed by any such assets. 
• Zero-Coupon Bonds- These bonds do not pay interest periodically but are issued at a discount to the face value. You will get the face value at the time of maturity. 
• Bonds with Call Provisions- A few bonds have these call provisions, meaning that the company can redeem them prior to maturity in case of a fall in interest rates. 
• Bonds with Put Provisions- Put provisions with a bond enables the bondholder to sell the asset back to the company prior to maturity. 

Read more : Corporate Bonds vs. Government Bonds

Risks Involved in Corporate Bonds

There are some risks you need to be aware of before investing in corporate bonds. They include the following: 

• Interest Rate Risks
  These bonds have exposure to interest rate risks just like their Government counterparts. 
• Default/Spread Risk
  There is always the risk that the borrower company may fail to repay the loan and may default on its commitments. The default level may vary based on the issuer’s underlying credit quality. 
• Company Going Out of Business
  In case the company issuing the bonds goes out of business altogether, investors may end up forfeiting not just the interest payments, but also their principal. This is why corporate bonds are generally perceived as riskier in comparison to Government bonds. 

Conclusion

Understanding the working of corporate bonds is essential. Remember, you do not get any ownership in the company issuing the same. However, the principal will be refunded at maturity, while earning attractive returns from these investments. Yet, doing your due diligence and checking credit ratings carefully are always a must before investing your money.