Not everybody has the capacity to handle the risks of the stock market. One however, is not satisfied with parking one’s money in fixed deposits or government bonds either, their interest rates being very low. For those who want the right blend of risk and yield, corporate bonds prove to be the perfect avenues for investment.
What are Corporate Bonds?
Companies regularly need funds for capital expenditure such as purchase of land and import of machinery or for operational expenses. For every such need they cannot rush to the capital market and raise money through public offerings nor would they want to borrow from banks and financial institutions all the time. Companies can resort to Corporate Bond issues at such times.
This means that companies accept money and issue bond certificates to people who wish to buy their bonds, wherein they promise to pay a certain sum of money on maturity usually for a period more than one year and also a fixed rate of interest on a regular basis. If companies accept money for a period of less than one year, it is called ‘commercial paper’.
What is the Relationship Between Bond Holders and The Company Issuing Corporate Bonds?
While shareholders are owners of the company, bond holders are creditors of the company. When a person buys a corporate bond, he is lending money to the company and is getting paid interest for the same.
Some Advantages of Corporate Bonds
- Corporate bonds are less risky than equity as the income from them is not affected by the vagaries of the stock market.
- Since the element of risk is higher than in government securities, they offer higher rates of interest. Also, corporate bonds are usually rated by rating agencies like Moody’s and Fitch. A lower rating will mean that the company will have to offer higher interest rates to make up for the higher degree of risk. In contrast, bonds of a company with a higher credit rating will have takers even at lower rates.
- Bond holders need not wait till maturity to get the principal amounts. In case they need funds they can sell the bonds in the market. Though these bonds are traded in the exchange, over the counter trades are more frequent. There may be however lack of liquidity which may make it difficult to get the best price.
- If the company issuing bonds goes bankrupt, then bond holders along with other creditors have an advantage over shareholders as they will have first claim to the assets of the company.
Corporate Bonds Terminology
- A company can insure its bonds so that in case of default by the company, bond holders will still be paid the principal and interest. Bond insurance can be taken only the company and not by the bond holders.
- Corporate bond yield is the percentage of return a bond holder gets on his investment and is determined by the interest rate and the amount he paid for the bond.
- Coupon rate of corporate bonds is the rate of interest payable on the bond.
- Corporate bonds may be convertible bonds, which means that these bonds can be converted into another type of security usually equity shares on a later date under certain conditions.
- If corporate bonds are ‘callable’, it means that the principal amount and the interest accrued can be paid before the date of maturity at the option of the issuer or due to some extraordinary circumstance.
Investing in corporate bonds is the perfect via media between high risk – high yield equity and the low risk- low yield bank deposits and government securities. By buying corporate bonds one gets to participate in a company’s growth and at the same time one’s investment is quite safe.