The economy is growing with a healthy spring in its steps, and no one wants to get left behind. Nobody really needs to either, with corporate bonds proving to be a widely useful financial tool for more than a couple of centuries now in the world of money-making.
What is a Corporate Bond?
A corporate bond is a legally binding agreement between two parties, issued most often by corporations, as a tool of capital generation. They provide companies with a rapid way to raise large amounts of stable funding and give the investors the promise of attractively high returns. Although it most often refers to those issued by large corporations, in general, a corporate bond could refer to any such agreement except those issued by a government in their own currency.
The trading of corporate bonds takes place in decentralized, dealer-based markets. Many of these are traded over the counter, providing good liquidity, i.e. the ability to sell the bond at one’s earliest convenience to obtain cash. The valuation of a corporate bond in the United States is decided by trading on credit spread, which is basically the difference between the yields offered by it and by that being offered by the government treasury.
What are the Benefits of Corporate Bonds?
The advantages of corporate bonds are aplenty and offer handsome returns to both parties in a thriving economic environment. Much of which has already been mentioned, the main benefits of corporate bonds are –
- The bonds provide rapid and steady capital funding to large corporations. This is of great convenience to companies that are growing aggressively and ambitiously. It aids greatly in further planning without planning about financial capital generation and provides sustainable growth.
- It helps them in being flexible with their cash and do all the things that they may be concerned with including research, production, paying wages and so on and so forth.
For the investor, corporate bonds are characteristic of offering higher yields and returns than any government issued bond. The terms for which corporate bonds last have a huge range, and larger corporations issuing them usually have a whole range from which an investor can choose from, letting them be creative with their financial goals as well.
As was said earlier, the market in which trading of these bonds happens also offer very high liquidity to the investor. Such high-promised returns on investment at such high levels of flexibility is indeed a treat for those with elaborate personal financial goals and make the idea of corporate bonds a dream come true.
Risk Factors in Corporate Bonds Investment
Now of course, for anything so good, there are a few disadvantages to them as well. The most glaring one being the high risks involved. As any seasoned investor would know, high yield values on corporate bonds and the risks associated with them are directly proportional to each other. It could be said that investors are actually being “compensated” for the high levels of risk corporate bonds carry with the high yield returns that they offer.
The risk associated is dependent on quite a number of variables. The variables that one should take into consideration before investing in corporate bonds are the practices of the issuing corporation, the market ratings of that corporation and the trends for the same, the overall market conditions at the time of investing, and last but certainly not the least, comparing the types of bonds on offer and comparing it to the local government bonds on offer. The common types of risks in corporate bonds that are worth investors digging their noses into are:
- A Credit Spread Risk, where the yield is insufficient to compensate with the market risks the corporate bond is floating on.
- An Interest Rate risk, where the yield values of the corporate bond are volatile, thereby changing their market values.
- Liquidity risk, that is whether there is a presence of a continuous market where an investor can sell a bond if he so wishes at any point in time.
- Inflation risk, where the rate of inflation blooms to become larger than the yields that are on offer, thereby making the deal simply not worth it.
- Supply risk, it is when a company offers a large number of bonds, thereby devaluing the bonds already out on the market which is a bane for their holders.
- Tax change risk is something that always remains on varying levels, where the government authority can change the taxation environment to either be more beneficial or hostile to bond investors.
Now the interest earned under the bond, which has come to be known as the coupon, is more often than not taxable for the investor, but tax deductible for the body that pays it. In the United States, these coupons are given in a semi-annual fashion. Rarely, the coupon can be zero. In this case, the investor buys the bond previously at a “discounted” price but collecting the full amount on maturity thereby benefitting.
There are also “callable bonds”. A so-called “call” option can be exercised by the investor, redeeming his capital before maturity. It is a fairly common practice in the High Yielding bond market. A less common practice is that of a “puttable bond” though. In this case, the investor can put the bond back in even after calling it before the maturity expires.
Other types of bonds which are also called convertible bonds, allow the investors the advantage of converting their bonds into equities. These can have a range of additional options to them, such as binge secured or unsecured, senior or subordinated, and be issued out of different parts of the given company’s capital finance structure.
In the modern world of business economics, with more people investing than ever before taking advantage of the markets around them and companies riding on this surf to do well and prosper to amazing heights, corporate bonds are indeed a treat to everyone in the field. The ease of trade, the flexibility they offer to all parties involved, the great many ways in which they can be played around with offer make these corporate bonds a great way to make money for any investor, be it the newcomer who’s still unsure about the markets, or the seasoned market player. Happy investing ahead!