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What is a ‘Corporate Bond’
A corporate bond is a debt security issued by a corporation and sold to investors. The backing for the bond is usually the payment ability of the company, which is typically money to be earned from future operations. In some cases, the company’s physical assets may be used as collateral for bonds.
BREAKING DOWN ‘Corporate Bond’
Corporate bonds are considered to have higher risk than government bonds. As a result, interest rates are almost always higher on corporate bonds, even for companies with top-flight credit quality. For example, as of 2016, 5-year U.S. Treasury bonds yield just over 1.08% on average, while the average yield on five-year corporate bonds is 1.57 for AA bonds and 1.79 for A bonds.
How Corporate Bonds Work
Corporate bonds are issued in blocks of $1,000 in par value. and almost all have a standard coupon payment structure. As the investor owns the bond, he receives interest from the issuer until the bond matures. At that point, the investor can reclaim the face value of the bond. Corporate bonds may also have call provisions to allow for early prepayment if prevailing rates change, and investors may also opt to sell bonds before they mature.
The least expensive bonds from some corporations may cost $5,000 or $10,000 rather than $1,000. In Australia, the face value of most corporate bonds is $100. Like other types of debt, bonds may have fixed interest rates that stay the same throughout the life of the bond, or they may have floating rates that change.
Why Do Corporations Sell Bonds?
Corporate bonds are a form of debt financing. They can be a major source of capital for many businesses, along with equity, bank loans and lines of credit. Generally speaking, a company needs to have some consistent earnings potential to be able to offer debt securities to the public at a favorable coupon rate. If a company’s perceived credit quality is higher, it becomes easier to issue more debt at low rates. When corporations need a very short-term capital boost, they may sell commercial paper, which is very similar to a bond but typically matures in 270 days or less.
The Difference Between Corporate Bonds and Stocks
When an investor buys a corporate bond, he lends money to the company. Conversely, when an investor purchases stocks, he essentially buys a piece of the company. The value of stocks rises and falls with the value of the company, allowing the investors to earn profits but also subjecting the investors to losses. With bonds, investors only earn interest rather than profits. If a company goes into bankruptcy, it pays its bondholders along with other creditors before its stockholders, making bonds arguably safer than stocks.
A type of bond, asset-backed securities (ABS) bundle together consumer debt, such as home loans, home equity lines of credit and credit card receivables. They may also include loans on mobile homes but not traditional mortgages. Institutional investors typically purchase ABS. ABS may be included in corporate bond mutual funds.