When discussing investments, stocks and bonds are often lumped together. Perhaps it’s because both are securities that are issued by corporations. Or perhaps it’s because they both carry a significant amount of risk.
Corporate bonds are debt securities that are sold to investors. They are created for the purpose of raising capital for a company, usually to help it expand and grow. The money raised through bonds is repaid to the bondholders, along with interest. It’s similar to when a consumer takes out a loan at the bank, and must repay the loan in installments that include principal and interest.
Like consumer loans, corporate bonds may be secured or unsecured. For secured bonds, specific assets of the company are used as collateral. If the company defaults on its payments, the collateral may have to be sold to pay investors. Unsecured bonds are backed by the company’s general assets.
Corporate bonds have terms that may be as long as 100 years. Usually, the term is 12 to 30 years. The term is the amount of time the corporation has to repay the full amount of principal plus interest. Payments are generally made every 6 months.
Investors may keep their bonds until they are paid in full, or they may sell them. Some purchase bonds with the intent to sell them and make a profit. In order for this strategy to work, the investor must buy when interest rates are high and sell when they are low.
The risk in corporate bonds lies in the possibility that the company may not be able to repay its debts. If the company files for bankruptcy, its bonds will be worthless. Because of this inherent risk, corporate bonds pay higher interest rates than government bonds.
There is no sure-fire way of knowing whether or not a particular bond will be repaid. But you can get an idea of the amount of risk from the company’s credit history. Moody’s and Standard and Poor’s are two firms that assign credit ratings to bond issuers. Those with good credit ratings can sell bonds with low interest rates, while those with poor credit histories must pay higher interest due to increased risk on the part of the investor.
Corporate bonds are sold through brokers. They may be purchased individually or in bond funds. These funds combine a number of bonds into one package to reduce risk while maintaining a reasonable rate of return. Those who invest in bond funds may keep their shares indefinitely, because the bonds in the fund have different maturity dates. Once a certain bond has matured, it is replaced with another one.
Investing in corporate bonds is risky. But it can also bring an impressive rate of return. Few investors put all of their money into bonds, but most include them in their portfolios along with lower risk investments.
