Corporate bonds are debt obligations issued by companies to fund capital improvements, expansions, debt refinancing or acquisitions. Interest is subject to federal, state, and local taxes.
Fixed-rate coupons represent the annual interest rate paid, usually every six months, although some bonds pay annually, quarterly, or even monthly. The payment amount is calculated as a percentage of the par value, regardless of the purchase price or current market value. With corporate bonds, one bond represents $1,000 par value, so a 7% fixed-rate coupon will pay $70 per bond annually ($1,000 × 7%). The payment cycle is not necessarily aligned to the calendar year; it begins on the “Dated Date,” which is either on or soon after the bond’s issue date, and ends on the bond’s maturity date, when the final coupon and return of principal payment are paid.
Investment grade vs. non-investment grade (high yield)
Corporate bonds are generally rated by one or more of the three primary ratings agencies. The firms base their ratings on the bond issuer’s financial health and ability to pay interest payments and return the bondholders’ principal. Rated bonds fall into one of two categories: investment grade or non-investment grade (also known as high yield). Investment grade bonds are considered to carry less risk and, therefore, generally pay lower interest rates than non-investment grade bonds. Non-investment grade bonds are considered to be higher risk or speculative investments. The higher yield reflects an increased risk of default. A company’s financial health can change, and when it does, its bonds’ ratings may change as well. So an investment grade bond could become non-investment grade over time and vice versa.
Zero-coupon corporate bonds are issued at a discount from face value (par), with the full value, including imputed interest, paid at maturity. Interest is taxable, even though no actual payments are made. Prices of zero-coupon bonds tend to be more volatile than bonds that make regular interest payments.
The coupon on a floating-rate corporate bond changes in relationship to a predetermined benchmark, such as the spread above the yield on a six-month Treasury or the price of a commodity. This reset can occur multiple times per year. The coupon and benchmark can also have an inverse relationship.
Variable and adjustable-rate
Variable- and adjustable-rate corporate bonds are similar to floating-rate bonds, except that coupons are tied to a long-term interest rate benchmark and are typically only reset annually.
Callable and puttable
The issuer of a callable corporate bond maintains the right to redeem the security on a set date prior to maturity and pay back the bond’s owner either par (full) value or a percentage of par value. The call schedule lists the precise call dates of when an issuer may choose to pay back the bonds and the price at which they will do so. The callable price is generally expressed as a percent of par value, but other all-price quotation methods exist.
With a puttable security, or put option, the investor has the right to put the security back to the issuer, again at a set date or a trigger event prior to maturity. A common example is the “survivor’s option,” whereby if the owner of the bond dies, the heirs have the ability to put back the bond to the issuer and typically receive par value in return.
Step-up corporate bonds pay a fixed rate of interest until the call date, at which time the coupon increases if the bond is not called.
Interest on step-down securities is paid at a fixed rate until the call date, at which time the coupon decreases if the bond is not called.
Convertible bonds can be exchanged for a specified amount of the common stock of the issuing company, although provisions generally restrict when a conversion can take place. While these bonds offer the potential for appreciation of the underlying security, prices may be susceptible to stock market fluctuations.
The range of corporate bonds issued each year allows investors to tailor a bond portfolio around specific needs. Investors should consider that each isser has its own unique risk profile.
An active secondary market exists for many corporate bonds. This creates liquidity for investors. Investors need to remember that some issues are thinly traded, which may impact pricing, and may pose a challenge when selling.
Customers are able to access our new issue corporate bond calendar online. Each week, a number of new issue corporate bonds are available for purchase.
Most corporate bonds are rated by at least one of the major rating agencies. ACAP Trading’s BOLTS™ platform offers both investment grade and non-investment grade bonds, which are classified according to their rating. When considering an investment in corporate bonds, remember that higher potential returns are typically associated with greater risk.
Corporate bonds are among the highest yielding fixed income securities. In fact, the yield differential over Treasuries may be great enough to outpace inflation over the long term. Because interest is fully taxable, buyers should evaluate their tax situations before investing.
Credit and default risks
Corporate bonds are subject to credit risk. It’s important to pay attention to changes in the credit quality of the issuer, as less creditworthy issuers may be more likely to default on interest payments or principal repayment. If a bond issuer fails to make either a coupon or principal payment when they are due, or fails to meet some other provision of the bond indenture, it is said to be in default. One way to manage this risk is to diversify across different issuers and industry sectors.
Price volatility of corporate bonds increases with the length of the maturity and decreases as the size of the coupon increases. Changes in credit rating can also affect prices. If one of the major rating services lowers its credit rating for a particular issue, the price of that security usually declines.
A bond’s payments are dependent on the issuer’s ability to generate cash flow. Unforeseen events could impact the issuers ability to meet those commitments.
Many corporate bonds may have call provisions, which means they can be redeemed or paid off at the issuer’s discretion prior to maturity. Typically an issuer will call a bond when interest rates fall, potentially leaving investors with a capital loss or loss in income and less favorable reinvestment options. Prior to purchasing a corporate bond, determine whether call provisions exist.
Some bonds give the issuer the right to call a bond, but stipulate that redemptions occur at par plus a premium. This feature is referred to as a make-whole call. The amount of the premium is determined by the yield of a comparable mature Treasury security, plus additional basis points. Because the cost to the issuer can often be significant, make-whole calls are rarely invoked.
Corporate bond issuers fall into four main sectors: industrial, financial, utilities, and transportation. Bonds in these economic sectors can be affected by a range of factors, including corporate events, consumer demand, changes in the economic cycle, changes in regulation, interest rate and commodity volatility, changes in overseas economic conditions, and currency fluctuations. Understanding the degree to which each sector can be influenced by these factors is the first step toward building a diversified bond portfolio.
Interest rate risk
If interest rates rise, the price of existing bonds usually declines. That’s because new bonds are likely to be issued with higher yields as interest rates increase, making the old or outstanding bonds less attractive. If interest rates decline, however, bond prices usually increase, which means an investor can sometimes sell a bond for more than face value, since other investors are willing to pay a premium for a bond with a higher interest payment. The longer a bond’s maturity, the greater the impact a change in interest rates can have on its price. If you’re holding a bond until maturity, interest rate risk is not a concern.
Like all bonds, corporate bonds are subject to inflation risk. Inflation may diminish the purchasing power of a bond’s interest and principal.
In addition to the risks mentioned above, there are additional considerations for bonds issued by foreign governments and corporations. These bonds can experience greater volatility, due to increased political, regulatory, market, or economic risks. These risks are usually more pronounced in emerging markets, which may be subject to greater social, economic, regulatory, and political uncertainties.
ACAP Trading offers primary and secondary liquidity on Corporate bonds and offerings can be found on BOLTS™. To view our Bonds On-Line Trading System™, please click here.