Investing in Corporate Bonds

If you’re looking to invest in a company but don’t want to buy stocks or get involved with the stock market, corporate bonds may be an option. To better understand what a corporate bond is though, you should first know the basics of a bond.

A bond is way for an issuer to raise money from a lender or lenders. These bonds are issued for a specific amount with an agreed upon interest rate to be paid at the end of a fixed period. At the end of that period, the bond has matured and the money must be paid plus the interest owed.

Corporate bonds are bonds issued by a company to raise money – most of the time to be able to expand business – either by opening another location or building a new plant. According to investinginbonds.com, there are five main types of issuers of corporate bonds:

1 Public utilities

2 Transportation companies

3 Industrial corporations

4 Financial services companies

5 Conglomerates

Corporate bonds can also be divided up into the three time categories – or lengths to maturity. Short-term corporate bonds mature in five years or less. While medium term bonds mature in five to 12 years. Long-term bonds don’t mature for 12 years or longer.

Some people are attracted to corporate bonds because they typically carry, or yield, a higher interest rate than government-issued bonds. The flip side of that though is government bonds are more secure. The reason corporate bonds yield higher interest rates is because there is usually a higher risk for default.

Because the interest rate is known and the amount of time is fixed, the lender knows exactly what the profit will be for giving the money to the issuer. This is different from buying stock in that the value of stocks can rise and fall, but the bond retains its value until it matures. Bonds are also different than stock, because bonds do not give you ownership in the company.

Also, interest paid on a corporate bond is not paid all at once when the bond matures. Interest is usually paid semiannually and the original amount loaned to the company, also known as the principal, is what is paid back in full once the bond matures. Before purchasing a corporate bond, you should also become aware of the tax laws for interest you earn. Interest paid on corporate bonds is taxable by the government.

Because bonds can be bought and sold on the market, similar to stocks, it’s better to be aware of how the interest-rate risk is measured. This probably seems complicated. But here is what you should keep in mind. If you plan to keep your bond until it matures, you shouldn’t have to worry about the interest-rate risk. Most bonds carry a fixed interest rate, so your interest rate will not change and you will know exactly what your profit will be once the bond or bonds mature.

But if you plan to buy and trade bonds on the bond market, you should know that if interest rates go up, the bonds previously purchased at lower interest rates are actually worth less. That’s because new bonds will be issued with higher rates. That means you would have to sell the bonds with lower interest rates at a discounted price.

The opposite is true if interest rates go down. You’ll be able to sell your bonds with higher interest rates attached to them for more money. Therefore the value goes up for those bonds when interest rates fall.

But how do you buy and sell bonds? Bonds are typically traded in an over-the-counter (OTC) market by dealers and brokers. Today, most corporate bonds are traded electronically; and there is no central location, like in the New York Stock Exchange, where bond most trades happen. Though some bonds are traded on the stock market, it’s not as common as the OTC market.