What Are Corporate Bonds?
Corporate bonds are debt instruments created by companies for the express purpose of raising capital. Because they pay a specific amount of interest on a regular basis, they are considered fixed-income securities.
How Does a Corporate Bond Work?
A corporate bond represents a loan agreement between the issuer and the investor. The terms of the bond require the issuer to repay the borrowed amount (i.e. principal) by a specific date (i.e. maturity).
How Long Are Corporate Bond Maturities?
Some bond maturities are short-term (a year or less) while others are intermediate-term (usually two to 10 years). Long-term bonds may last for a period of between 10 and 30 years.
Note: Bonds with maturities of less than 10 years are typically called notes.
What Does Face Value Mean?
The face value (or par value) of a bond represents the amount to be repaid at maturity. Corporate bonds usually have $1,000 face values, meaning that the issuer pays the holder $1,000 on the maturity date. Baby bonds have face values of $500.
Note: The face value is not the market price of the bond.
When Is the Bond Principal Paid?
Although issuers don’t usually repay the principal until the maturity date, investors are occasionally paid a specific amount of interest on a semiannual basis. In some cases – when the bonds are serial bonds – specific principal amounts are due on specified dates.
The interest rate (or coupon rate) on a bond is the percentage of face value that the issuer pays a bondholder on an annual basis.
Corporate Bond Example
You purchase a bond with a 5% coupon rate from Company XYZ. The bond has a face value of $1,000. This means you will receive $50 in interest payments per year ($1,000 x 0.05).
Since corporate issuers usually make payments in six-month installments, you might receive $25 in January and the other $25 in June.
For information about the payment schedule, be sure to check the prospectus, indenture agreement, and bond certificate for disclosures.
Are Corporate Bonds Safe?
In the grand scheme of investment choices, corporate bonds are relatively safe, liquid investments. This depends, however, on several factors like the investor's tolerance for risk and their investment horizon.
Corporate bonds aren’t generally safer than government bonds, certificates of deposit, or most municipal bonds. That’s because corporations are more likely to default on their obligations than the US government, local governments, and banks. This added risk means that corporate bonds typically offer higher returns than these instruments.
Corporate Bonds vs. Stock
Owning a company's debt is considerably different than owning a company's stock. For example, bondholders cannot vote and aren’t entitled to dividends.
Debt also ranks higher than equity, meaning that bondholders are among the first in line to be repaid in the event the issuer liquidates. Shareholders might receive some proceeds from the liquidation after this (if there is anything left). Seniority provides an extra level of security for bondholders.