What are Corporate Bonds?

Please note that Blueberry does not issue or make a market in fixed income instruments, including treasury bonds and corporate bonds. This article is for informational purposes only and does not constitute financial advice or a recommendation to invest.

Corporate bonds provide diversification opportunities, allowing traders to balance their portfolios and manage risk. The US Corporate A Effective Yield currently stands at 4.82% (as of 9th September 2024), higher than its previous day's rate of 4.80% and last year's rate of 5.53%. This current yield exceeds the long-term average of 4.54%.

With steady interest rates, investors can leverage their portfolio earnings via corporate bonds. In this article, we will explore these concepts further. 

Define corporate bonds

Corporate bonds are debt securities that corporations issue to raise capital. When one purchases a corporate bond, they're lending money to the company for the company to cover its expenses. In return, the company promises to pay the investor interest on their investment and repay the principal amount when the bond matures.  

Corporate bonds are traded on both the primary market through a brokerage firm and the secondary market, meaning their price can fluctuate based on factors such as interest rate changes and the company's financial performance.

Type of corporate bonds

Investment-grade bonds

These bonds are issued by companies deemed to have a low risk of default by credit rating agencies (typically rated BBB- or higher by Standard & Poor's or Baa- or higher by Moody's). They generally offer lower interest rates than higher-risk bonds.

High-yield bonds (junk bonds)

These bonds are issued by companies with a higher perceived risk of default (typically rated below BBB- or Baa-). To compensate for the increased risk, they offer higher interest rates.

Convertible bonds

Under certain conditions, these bonds can be converted into common stock of the issuing company. If the company's stock price significantly appreciates, investors can potentially earn higher returns.

Callable bonds

These bonds give the issuer the right to redeem them before maturity. This can be advantageous for the issuer if interest rates decline, but it can be disadvantageous for the bondholder if the bond is called before they desire to redeem it.

Puttable bonds

These bonds give the bondholder the right to sell them back to the issuer at a predetermined price before maturity. This can be advantageous for the bondholder if interest rates rise, as they can sell the bond back and reinvest the proceeds in a higher-yielding security.

Zero-coupon bonds

These bonds are sold at a significant discount to their face value and do not pay any periodic interest. Instead, the interest is earned through the difference between the purchase price and the face value at maturity.

Features of corporate bonds

• Bonds are often issued with a face value of $1,000, but other denominations may be available

• Bonds issued by companies with higher credit ratings offer lower interest rates due to the lower perceived risk of default

• Interest payments are made annually or semi-annually 

• Bonds can also be non-callable, where the issuer cannot redeem the bond before maturity 

• Bonds can be secured (backed by specific assets of the issuer, such as property or equipment) or unsecured (not backed by specific assets and also known as debentures)

• Coupon rate, maturity, credit rating, and market interest rates affect the bond's yield to maturity 

• There are some restrictions on debt levels, dividend payments, and asset sales with corporate bonds

Advantages and risks of investing in corporate bonds

Advantages 

1. Higher yields: Corporate bonds offer higher interest rates than government bonds, as investors demand a premium to compensate for the increased risk of default.

2. Regular income: Bondholders receive regular interest payments, providing a steady income stream.

3. Potential for capital appreciation: If the bond's price increases in the secondary market, investors can gain from selling it at a higher price than their purchase price.

Risks 

1. Credit risk: The primary risk associated with corporate bonds is the issuer defaulting on its debt. If the company becomes insolvent, bondholders may lose some or all of their investment.

2. Interest rate risk: Bond prices are directly affected by interest rate changes. If interest rates rise, the market value of existing bonds with lower coupon rates may decline.

3. Market risk and liquidity concerns: The market price of corporate bonds can fluctuate due to various factors, including economic conditions, industry trends, and company-specific news. In some cases, selling a corporate bond at a fair price may be difficult, especially for less liquid bonds.

How to purchase a corporate bond?

Research corporate bonds

Before investing, thoroughly research corporate bonds. Understand their features, risks, and rewards. Consider factors like credit ratings, maturity dates, and interest rates.

Determine investment goals

Define the investment objectives. Investors need to understand if they are seeking regular income, capital appreciation, or a combination of both. This will help them choose the right type of corporate bond.

Open a brokerage account

To purchase corporate bonds, traders need a brokerage account. Choose a broker that offers bond trading services.

Select the bond type and issuer

Based on the research and investment goals, select the specific type of corporate bond (such as investment-grade, high-yield) and the issuer. Consider factors like creditworthiness, coupon rate, and maturity.

Place order

Once the investor has chosen a bond, place the order through the brokerage account. Specify the quantity of bonds one wants to purchase and the price they will pay.

Review and confirm the purchase

Please carefully review the order details, including the bond's price, total cost, and settlement date. Then, confirm the purchase to complete the transaction.

Entering the bonds market

Investors can purchase corporate bonds individually or through funds like ETFs. When investing in corporate bonds, consider factors such as credit risk, interest rate risk, and market liquidity. 

By carefully selecting bonds and diversifying the portfolios, investors can potentially gain from regular income, capital appreciation, and exposure to different markets. However, conducting thorough research and considering investment goals and risk tolerance before making any decisions is essential. 

Please note that Blueberry does not issue or make a market in fixed income instruments, including treasury bonds and corporate bonds. This article is for informational purposes only and does not constitute financial advice or a recommendation to invest.