Corporate Bonds: Definition and How to Invest
Companies need capital to fund ambitious projects, and they often turn to investors to raise funds. Teaming up with investment banks to issue corporate bonds gives these firms the money they need, and it also presents an opportunity for investors to grow their wealth.
With a corporate bond, an investor receives interest payments until maturity. At that point, the investor receives the principal back and likely nets a gain in the process. Corporate bond values fluctuate based on a company's ability to repay the bond, but these assets aren't as volatile as stocks. Here's how to make the most of corporate bond investments:
What is a corporate bond?
What are convertible bonds?
How to analyze a corporate bond.
How interest rates affect bond values.
Corporate bonds vs. stocks.
What Is a Corporate Bond?
A corporate bond is a type of debt instrument that corporations sell to investors to raise capital. This financing strategy is cheaper than equity financing and doesn't require a firm to give up shares.
Investors receive interest payments, also known as coupon payments, until the bond's maturity date. Corporations can decide whether to issue fixed or variable interest rates for their bonds. Fixed rates provide consistent payments, while the payments on a variable rate bond depend on how interest rates fluctuate.
"Investment grade starts at BBB and above. Anything below investment grade increases repayment risk, and the investor needs to carefully weigh the rationale." - Arvind Ven, founder and CEO of Capital V Group
Investors can buy these bonds at face value when issued or trade them on the secondary market. Face value is the amount you must pay to buy a bond. Most bonds start with a $1,000 face value, but that value fluctuates on the secondary market.
You can hold onto a bond until maturity to receive interest payments and your principal, or you can trade it. While many bonds expire at maturity, some firms make their corporate bonds callable.
During a call, a firm can buy up the corporate bonds it previously issued to stop paying interest. This practice allows corporations to capitalize on lower interest rates by reissuing the same debt but at a lower rate.
What Are Convertible Bonds?
Investors can also filter their search to find convertible bonds. Under certain conditions, these bonds give investors the opportunity to convert the bond into shares. A bondholder can decide whether to hold onto the bond until expiration or convert it into shares, and its conversion ratio indicates how many shares an investor can receive for making a swap. For example, a single convertible corporate bond with a 3-to-1 ratio can be exchanged for three shares of common stock.
Corporate bonds attract investors looking for low-risk cash flow. Some people transitioning to retirement buy more bonds to have stable returns and less volatility.
You can also buy government bonds to receive steady interest payments, but corporate bonds usually have higher interest rates due to the perceived risk. Even firms with pristine balance sheets and cash supplies tend to have higher interest rates on their bonds than the government.