Understanding Corporate Bonds

Corporate bonds are a cornerstone of the investment world and one of the largest components of the U.S. bond market, according to Investor.gov. Here’s a guide for understanding corporate bonds.

What Are Corporate Bonds?

When investors buy corporate bonds for sale, they are essentially lending money to the business issuing the bond, which functions like an IOU. When the bond matures, or comes due, usually the company must pay back the amount that was lent, known as the principal, in addition to interest, according to Investor.gov.

Uses of Corporate Bonds

New corporate bond offerings proceeds are used for a variety of purposes, from investing in research to refinancing debt, according to Investor.gov. The amount that a business may need to grow and fund operations may be more than what a bank can provide, which is a top reason for the $41 trillion U.S. bond market, according to Forbes.com.

Comparison to Stocks

When you buy stocks, you have partial ownership in the company and receive dividends, but this is not the case when you buy bonds, according to Forbes.com. Therefore, for bond holders, investments are limited to receiving interest and the principal on the bond, even if the company’s stock price rises or falls. This is why buying bonds is generally considered less risky than buying stocks, states Investor.gov. The company, however, must still meet the legal obligation and corporate governance to the bondholder, even in the event of a bankruptcy, according to Investor.gov.

Risks of Corporate Bonds

When you buy bonds, there’s a risk that the company will default on its bonds. Therefore, it’s important consider top rated corporate bonds and to look at corporate bond rates chart as assigned by credit rating agencies before buying its bonds, states Investor.gov. Bonds with a longer-term maturity tend to have higher interest rates but are usually considered to be riskier than short- or medium-term bonds.

Type of Interest Payments

Bonds can pay a fixed interest rate, which is referred to as the coupon rate. This fixed rate doesn’t fluctuate even if there are changes in the market interest rate. However, some bonds have floating rates that change based on market interest rates. Other bonds, known as zero-coupon bonds, pay no interest rate, but when the bond matures, the bondholder is paid back more than the initial principal payment, explains Investor.gov.