Corporate Bonds

Corporate bonds are debts issued by industrial, financial and service companies to finance capital investment and operating cash flow. In terms of total face value of bonds outstanding, the corporate bond market is bigger than each of the markets for municipal bonds, U.S. treasury securities, and government agencies securities. Investors in corporate bonds have a wide range of choices when it comes to bond structures, coupon rates, maturity dates, credit quality and industry exposure.

At its simplest, when you purchase a corporate bond, you are providing a company with cash to finance its operations in exchange for a specified interest rate on the money you have lent as well as the return of principal.

There are a number of key variables to look at when investing in corporate bonds: the bond's maturity, redemption features, credit quality, interest rate, price, yield and tax status (interest from most corporate bonds is subject to federal, state and local taxes). Together, these factors help determine the value of a bond investment and the degree to which it matches your financial objectives.

Like Treasuries, agency bonds and municipal bonds, most debt securities carry an interest rate that is fixed until maturity and is a percentage of the principal amount. Typically, investors receive interest payments semiannually. For example, a $1,000 bond with an 8% interest rate will pay investors $80 a year, in payments of $40 every six months. When the bond matures, investors receive a semiannual interest payment and the return of their principal.

Some issuers issue debt where the interest is floating - i.e., is reset periodically in line with changes in a base interest rate index, such as the rate on Treasury bills.

A bond's maturity refers to the specific future date on which the investors' principal will be repaid. Bond maturities generally range from one day up to 30 years.

Some bonds have "call" provisions that allow the issuer to repay an issue's principal at a specified date before maturity. Bonds are commonly "called" when prevailing interest rates have dropped significantly since the time the bonds were issued. As an example, if you have a GE bond that pays 9% but current interest rates are 6%, GE may decide to refinance your bond by calling it, then doing another bond issuance at a lower rate. GE's actions would be similar to a homeowner who decides to refinance their mortgage.

Before you buy a bond, always ask if there is a call provision and, if there is, be sure to obtain the "yield to call" as well as the "yield to maturity". Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early.

Bond choices range from the highest credit quality U.S. Treasury securities, which are backed by the full faith and credit of the U.S. government, to bonds that are below investment-grade and considered speculative. Since a bond may not be redeemed, or reach maturity, for years - even decades - credit quality is another important consideration when you are evaluating a fixed income investment.

When a bond is issued, the issuer is responsible for providing details as to its financial soundness and creditworthiness. This information is contained in a document known as an Offering Prospectus that will be provided to you by your investment advisor.

Rating agencies assign ratings to many bonds when they are issued and monitor developments during the bond's lifetime. Securities firms and banks also maintain research staffs which monitor the ability and willingness of the various companies, governments and other issuers to make their interest and principal payments when due.

In the United States, major rating agencies include Moody's Investors Service, Standard & Poor's Corporation and Fitch Ratings. Each of the agencies assigns its ratings based on in-depth analysis of the issuer's financial condition and management, economic and debt characteristics, and the specific revenue sources securing the bond. The highest ratings are AAA (S&P and Fitch Ratings) and Aaa (Moody's). Bonds rated in the BBB category or higher are considered investment-grade; securities with ratings in the BB category and below are considered "high yield", or below investment-grade. While experience has shown that a diversified portfolio of high-yield bonds will, over the long run, have only a modest risk of default, it is extremely important to understand that, for any single bond, the high interest rate that generally accompanies a lower rating is a signal or warning of higher risk.

Usually, rating agencies will signal they are considering a rating change by placing the security on Credit Watch (S&P), Under Review (Moody's) or on Rating Watch (Fitch Ratings).

Corporate bonds can be purchased through a broker. Usually the minimum to purchase a corporate bond is $5,000.