Corporate Bonds

Definition

Corporate bonds are debt securities issued by corporations to raise long-term financing. They represent a loan from investors to the issuing company, with the company agreeing to pay the bond's face value back at maturity along with periodic interest payments.

5 Must Know Facts For Your Next Test

1. Corporate bonds offer investors a steady stream of income through regular interest payments, making them a popular fixed-income investment.
2. The coupon rate on a corporate bond is set when the bond is issued and remains fixed throughout the bond's lifetime.
3. Bond yields fluctuate inversely with bond prices, so as bond prices rise, yields fall, and vice versa.
4. Higher-rated bonds, such as those with an 'A' or 'AA' rating, typically offer lower yields than lower-rated, riskier bonds.
5. Corporate bonds can be secured by specific assets or unsecured, with unsecured bonds known as debentures.

Review Questions

• Explain how corporate bonds are used by companies to raise long-term financing.
  • Companies issue corporate bonds to raise long-term capital for various purposes, such as funding new projects, expanding operations, or refinancing existing debt. By selling bonds, companies can access a large pool of investors and spread out their financing needs over an extended period, often at a lower cost than obtaining a bank loan. The bond's face value, coupon rate, and maturity date are all negotiated between the company and investors, providing flexibility in structuring the financing.
• Describe the role of the securities markets in the issuance and trading of corporate bonds.
  • The securities markets, both primary and secondary, play a crucial role in the corporate bond market. In the primary market, companies issue new corporate bonds, which are then purchased by investors such as institutional investors and individual investors. Once issued, corporate bonds can be traded on the secondary market, where investors can buy and sell existing bonds. The secondary market provides liquidity and price discovery for corporate bonds, allowing investors to adjust their portfolios and companies to refinance their debt as needed. The securities markets facilitate the efficient allocation of capital and risk in the corporate bond market.
• Analyze how factors such as credit risk and interest rates influence the pricing and yields of corporate bonds.
  • The pricing and yields of corporate bonds are heavily influenced by the issuer's credit risk and prevailing interest rates. Companies with higher credit ratings, indicating lower default risk, typically offer lower coupon rates and yields on their bonds compared to companies with lower credit ratings. As interest rates rise, the market prices of existing corporate bonds fall, causing their yields to increase. Conversely, when interest rates decline, the market prices of corporate bonds rise, leading to lower yields. Investors must carefully consider these factors when evaluating the risk and return profile of corporate bonds as part of their investment portfolios.

Related terms

Coupon Rate: The interest rate paid by the bond issuer to the bond holder, expressed as a percentage of the bond's face value.

Bond Yield: The annual return on a bond, expressed as a percentage of the bond's market price.

Bond Rating: A measure of a bond's credit quality and default risk, assigned by credit rating agencies such as Moody's and S&P.