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Corporate bonds are similar to government bonds: When investors buy corporate bonds they are loaning a company money for a specified period of time. The company agrees to pay interest for that time. When the bond reaches maturity, the company returns the principal.
Corporations typically issue bonds, usually in $1,000 increments, in order to raise funds for capital improvements, acquisitions, and other needs. Because corporate bonds carry more risk, these bonds typically offer a higher interest rate.
It’s also possible to invest in corporate bonds via exchange-traded funds (ETFs) or mutual funds.
Key Points
• Corporations issue bonds to raise funds for various needs.
• Investors typically receive semi-annual interest payments until the bond matures.
• Corporate bonds are usually issued in $1,000 blocks and generally offer higher rates than Treasurys due to higher risk.
• Some corporate bonds offer a fixed interest rate, while others pay a floating rate.
• Bond-focused mutual funds and ETFs are alternative ways to invest and may offer additional portfolio diversification.
What Is a Corporate Bond?
A bond is a debt security that functions much like an IOU. When an investor buys a corporate bond, they are effectively lending money to that company for a specified period of time, with the agreement that the company will pay interest until the bond matures, at which time the company repays the principal.
What Is the Purpose of Bonds?
Governments and companies issue bonds in order to raise funds for different needs. For example, a state might issue bonds to build a new bridge, and the U.S. Treasury issues Treasury Bills (T-Bills) to cover its expenses.
Corporations also sell bonds to raise capital. They might use the money raised through these financial securities to reinvest in their business, pay down debts, or even buy other companies.
The Size of the Bond Market
Bonds make up more of the global markets than equities, worth about $145.1 trillion in 2024 versus $126.7 trillion for global equity market capitalization, according to the Securities Industry and Financial Markets Association (SIFMA). The U.S. fixed income market is the biggest in the world, making up 58.2% of global securities.
How Do Corporate Bonds Work?
As noted, corporate bonds follow similar rules to other types of bonds. Say an investor buys $10,000 worth of bonds from Company A, at a certain interest or coupon rate, for a specified time period until maturity.
These bonds might have shorter terms (e.g, up to five years); medium terms (between five and 12 year maturities); or longer terms (more than 12 years).
The investor can expect interest payments, usually semi-annually, until the bond matures — at which point the company repays the original $10,000 in principal.
Bond Terminology
To understand the bond market and how bonds work, it helps to know a few important terms:
• Issuer: The entity issuing bonds to raise money (e.g., a government, municipality, or a corporation).
• Par Value or face value: Also known as the nominal value of the bond, the par value is the amount the investor pays for the bond (i.e., the dollar amount of the loan) — which the bond issuer promises to repay when the bond reaches maturity. It’s the principal amount. This amount does not fluctuate over the life of the bond.
• Coupon rate: This is the interest rate paid by the bond issuer on the principal amount (e.g., a $100 bond with a 2% coupon will pay $2 per year). Some coupon rates are fixed. Some can be variable.
• Maturity: The date at which a bond’s issuer must repay the original bond value to the bondholder.
• Price: A bond’s price can change based on a bond’s rating, its interest rate, and time left to maturity. The price is the amount an investor pays for a bond in the secondary market.
• Yield to maturity (YTM): Investors who buy and sell bonds on the secondary market often focus on a bond’s yield to maturity, which is different from the coupon rate. Bond yield represents the total return at maturity, incorporating the bond’s market price and the coupon rate.
Corporate Bond Ratings
Well-known ratings agencies, such as Moody’s, Standard & Poor’s, and Fitch, rate the creditworthiness of the bond issuer. The bond rating can influence the coupon rate, as it reflects the relative risk involved in purchasing the bond. More on ratings below.
The Potential for Diversification
Investors may find bonds appealing for a couple of reasons. The first is that bonds can provide a steady source of income from interest (i.e., coupon payments), which is why they are referred to as fixed-income securities. (That said, equities have historically outperformed bonds over time.)
Another reason is that bonds are generally not correlated with the stock market, and thereby may offer investors some portfolio diversification.
Benefits and Drawbacks of Corporate Bonds
While corporate bonds may offer some benefits to investors, it’s important to consider their drawbacks, as well.
| Benefits | Drawbacks |
|---|---|
| Bonds can provide some portfolio diversification. | Bonds may offer lower returns than other securities, such as stocks. |
| Many investors consider corporate bonds to be a riskier investment than U.S. government bonds. As a result, they tend to offer higher interest rates. | Corporate bonds carry a higher risk of default than U.S. Treasurys. |
| Bonds are relatively liquid, meaning it is easy to buy and sell them on the market. | Some bonds are “callable”, which means issuers can pay them back early. When that happens, bond holders don’t earn as much interest and may have to reinvest. |
Types of Corporate Bonds
There are three main ways to categorize corporate bonds:
Maturity Dates
This category reflects the bond’s maturity, which may range from one to 30 years. There are three maturity lengths:
• Short-term: Maturity of within five years.
• Medium-term: Maturity of five to 12 years.
• Long-term: Maturity of more than 12 years. Longer-term bonds typically offer the highest interest rates.
Risk
Every once in a while, a corporation defaults its bonds. The likelihood of default impacts a company’s creditworthiness, and investors should consider it before purchasing a bond. Bond ratings, assigned by credit rating agencies, can help investors understand this risk.
Bonds can be rated as:
• Investment grade: Companies and bonds rated investment grade are unlikely to default. High-rated corporate bonds — from AAA to BBB, depending on the agency — typically pay a slightly higher rate than government securities.
• Non-investment grade: Non-investment grade bonds are more likely to default. Because they are riskier, non-investment grade bonds tend to offer a higher interest rate and are often known as high-yield or junk bonds.
Coupon
Investors may also categorize bonds based on the type of interest rate they offer.
• Fixed rate: With a fixed-rate bond, the coupon rate stays the same over the life of the bond.
• Floating rate: Bonds that offer floating rates readjust interest rates periodically, such as every six months. The floating rate depends on market interest rates.
• Zero-coupon bonds: These bonds have no interest rate. Instead, the bond is sold at a discount. When the bond reaches maturity, the issuer makes a single payment that’s higher than purchase price (effectively paying interest).
• Convertible bonds: Convertible bonds act like regular bonds with a coupon payment and a promise to repay the principal. However, they also give bondholders the option to convert their bonds into company stock according to a given ratio.
Difference Between Corporate Bonds and Stocks
Bonds differ from other types of investments in a number of important ways.
When investors invest in stocks, they are buying ownership shares in the company. Share prices may fluctuate depending on the markets and the health of the company. If the company does well, the stock price may rise, and the investor can sell their shares at a profit. Additionally, some companies share profits with their shareholders in the form of dividends.
When an investor purchases a corporate bond, on the other hand, they do not own a piece of the company; they’ve given a loan to the company. The bondholder is therefore entitled to interest plus their original principal. Those amounts don’t change based on company profits or the stock price. When a company goes bankrupt, bondholders have priority over stockholders when it comes to claims on the issuer’s assets.
How to Buy Corporate Bonds
Investors interested in purchasing corporate bonds have a number of options to consider.
Direct Investment
Investors can buy individual corporate bonds directly through brokerage firms or banks. Corporations typically issue them in increments of $1,000. Much like investing in an initial public offering, or IPO, it can be tricky for retail investors to get in on newly issued bonds. Investors may need a relationship with the organization that’s managing the offering.
However, investors can also purchase individual bonds on the secondary market.
Bond Funds
Another way to gain access to the bond market is by purchasing bond funds, including mutual funds and exchange-traded funds (ETFs) that invest in bonds. These funds can be a good way to diversify a bond portfolio as they typically hold a diverse basket of bonds that tracks a bond index or a certain sector.
Retirement Accounts
Investors can also purchase bonds or bond funds through an Individual Retirement Account, or IRA, as well as an employer-sponsored retirement account such as a 401(k).
The Takeaway
Before buying bonds, it’s important that individuals consider how these securities might fit in with their financial goals, risk tolerance, and time horizon. For example, if you’re working toward retirement and have decades to save, you may want a portfolio that’s tilted toward stocks, since stocks generally tend to outperform bonds in the long run. If you’re close to your goal — or have a low appetite for risk — you may want to stick with bonds.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
Are corporate bonds a good investment?
Corporate bonds generally pay a higher rate of interest than government bonds, but they come with a higher risk of default. While some investors may find the income potential from corporate bonds appealing, others may not want the added risk exposure.
What’s the difference between a Treasury bond and a corporate bond?
All types of U.S. Treasury bonds, bills, and notes are issued by the United States government and “backed by the full faith and credit” of the same. The United States has never defaulted on its debts. Corporate bonds carry more risk, and therefore offer higher interest rates.
Are bonds safe if the market crashes?
Generally speaking, bonds are less likely to be impacted by a stock market crash, and therefore can provide some ballast in a portfolio during times of market volatility. That said, no investment is 100% guaranteed to be “safe” under any circumstances.
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