Corporate Bonds: Definition and Why to Invest

Corporate bonds are an attractive alternative to other means of raising capital, like issuing more shares. They also offer a higher interest rate than their government counterparts.

The Advantages of Corporate Bonds

Corporate bonds are much like other types of bonds, but differ in that they are sold to investors by independent companies, instead of by banks or government issuers.

Corporate bonds are attractive for a number of reasons. For one, they allow businesses to receive investment capital without having to offer shares. They can also be used as an alternative to other forms of financing.

They are advantageous for investors in that they allow for a degree of flexibility and stability. Some may have a put option included with them that allows investors to redeem their investment before its established maturity date. Similarly a call option included in a bond would allow the issuer to pay back their loan before the established maturity date.

The interest rates for corporate bonds are usually higher than for other types of bonds because they are issued by companies with potentially unstable revenue streams, compared to other bond issuers. This is the case even for companies not considered “below investment grade.” Because they have a higher risk of default, they usually offer investors a higher yield, at least in comparison to other types of bonds.

Corporate Bonds and Creditworthiness

The creditworthiness of corporate bonds is tied to the business prospects and financial capacity of the issuer.

The business prospects of companies are dependent on the economy and the competitive situation of industries. Issuers are grouped by industry, such as real estate, resource, and retail bonds. Industries with stable revenues and earnings are called “non-cyclicals,” whereas those whose revenues and earnings rise and fall with the economy and commodity prices are called “cyclicals.”

Issuers are also grouped by their credit ratings. Companies that have financial risk because of high levels of debt and variable revenues and earnings are called “below investment grade” or “junk” bonds because of their speculative nature. Higher quality corporate bonds are considered “investment grade.”

4 years ago