The Finance Tutor

Return to Homepage

Corporate Bonds 101

Corporate Bonds are issued by corporations in need of capital for operations and projects. Most corporate bonds offer semi-annual fixed-rate coupon payments. Others offer floating coupons. Some corporate bonds are known as convertible bonds because they can be converted into shares of common stock under specified circumstances.

Risk

Corporate bonds are historically among the riskier fixed-income securities because companies are much more susceptible than governments to financial and economic hardships. Liquidity problems, adverse supply and demand forces, increased market competition, and poor or unethical management practices have all been known to place financial strains on companies. Despite their risk, corporate bonds can be the most lucrative fixed income investments because investors are generally rewarded for the extra risk they incur.

Corporate bonds may be secured or unsecured. Secured corporates are backed by specific assets of the issuing company. Unsecured corporates, also known as debenture bonds, are backed only by the issuer’s creditworthiness. Some companies issue subordinated debenture bonds, which are riskier than traditional debentures because investors holding subordinated securities are among the last in the line of creditors to be paid in the event of a bankruptcy.

The research required for investing in corporate bonds is similar to that of equity investing. Credit Analysis, the analysis of an issuer’s debt service capabilities, is critical. The value of a corporate bond is determined to a greater degree by the credit quality of the issuing corporation than by prevailing interest rates. Credit rating agencies monitor the financial performance and credit capacity of many corporations (Reference the tutorial Credit Risk: A Comprehensive Analysis).

Corporate Bonds fall into two credit rating classifications: investment grade and high-yield. Bonds rated Ba/BB or below are considered high-yield. High-yield bonds, also known as junk bonds exploded into the markets in the 1980s. Despite criticism that high-yield debt has diluted the bond markets with difficult to manage risk and “cheap” money, these securities have made it possible for countless young companies with less than pristine credit quality to gain access to external funding.

Summary

The following chart details the advantages and disadvantages of Corporate Bonds:

Corporate Bonds

Advantages
     • Greater yields than treasuries and municipal bonds
     • Credit quality monitored by credit rating agencies
     • Investment-grade corporates are generally liquid
     • Generally issued in $1,000 face values.

Disadvantages
     • Riskier than treasuries and municipal bonds
     • Vulnerable to Interest Rate Risk
     • Often Vulnerable to Call Risk
     • High yield corporates have Liquidity Risk

Questions:

1. Differentiate between investment grade debt and high yield debt.

2. Define Credit Analysis.

Answers:

-Reference-