Corporate bonds are debts issued by corporations to raise money in order to expand their business. Although you can find these bonds listed on major exchanges, the great majority of trading for these bonds takes place in de-centralized, dealer-based markets. These markets constitute of bond dealers and brokers who sell over-the-counter (OTC) throughout the country, often utilizing electronic transaction systems.
When you buy these bonds, you are essentially lending money to the corporation which promises to return the money on a specified maturity date. In return, the corporation pays you a stated rate of interest until that date. This interest, which is liable to tax, is generally paid semi-annually. These bonds do not give you any ownership rights within the corporation, as is the case with owning stocks.
One clear and significant advantage of corporate bonds is the higher level of yields when compared with government bonds or CDs. Other than this, these bonds also allow you to add diversity to your investment portfolio, since you have the option of choosing from a variety of sectors and company structures to best meet your investment aims. This can add stability to your portfolio, which is one of the main reasons for buying bonds in the first place.
These advantages, however, come at the price of the greater risks associated with corporate bonds. In the event that a company goes down, you may lose some or all of your money. Then there’s the general economic environment. In times of economic crisis, the value of your bonds may plummet alongside the value of the stocks of the company.
Liquidity can also be an issue. You may not always be able to immediately sell your bonds at a fair price. Should you employ the services of a broker for this task, you may need to pay a sizeable mark-up to sell off your bonds. You should look into the marketability of any bonds you buy if you feel it is likely that you might be selling them before they reach maturity.
As a general safe-guard against non-payment on the part of the corporation, take into consideration the evaluation and rating assigned to corporate bonds based on credit history and ability to repay obligations. A higher rating means a safer investment, as it indicates a higher likelihood of the repayment of principal and interest.
Interest rates also need to be taken into consideration when investing in corporate bonds. Just as with any other bonds, corporates tend to rise in value following a drop in interest rates, and they fall in value when interest rates rise. The longer the maturity of your bond, the greater price volatility should you expect. This interest-rate risk though may be less of a concern to you if you intend to hold a bond till maturity, at which point you would simply receive the face value of your bond.
Overall, incorporating corporate bonds into your investments, if done in a smart way, can not only diversify your portfolio, but can also provide you with a steady, dependable income while preserving your principal amount.