What are bonds?
Corporate bonds, also known as business bonds, are among the most commonly-traded investments on the secondary market. Companies often use them to raise capital at a more favourable rate than issuing stock.
Bonds are issued by companies and purchased by investors. They essentially act as a loan, enabling companies to finance new projects and facilitating capital expenditure. In purchasing a bond, the buyer (or bondholder) essentially lends money to the company (bond issuer). The company then makes a pre-established number of regular payments with either a fixed or variable interest rate. These interest payments are known as a ‘coupon’. The coupon rate is an annual sum expressed as a percentage of the bond’s par value. So, a business bond with a face value of £1000 that pays an annual coupon of £75 per year has a coupon rate of 7.5%.
When the bond reaches its maturity date, it expires, and the value of the investment is repaid. Bond prices are largely dictated by supply and demand, although bond prices tend to fall as interest rates rise.
Examples of bonds
Business bonds are not the only type of bonds that investors can find on the market. There are several other types of bonds, each with its own risk to reward ratios. The main types of bonds traded in the UK include:
Government bonds (gilts)
Aside from business bonds, government bonds or gilts are one of the most common instruments on the bond market. Gilts are a fixed-income form of security and are considered very low risk. Many see them as an alternative to cash savings, potentially yielding greater rewards while still very low in risk.
Investors can purchase UK government bonds or buy overseas government bonds. Keep in mind that investments in some governments are riskier than others.
Municipal bonds are similar to government bonds. Local governments and non-profit organisations often use them to fund infrastructure projects like public transport, water systems or utilities.
One of the more divisive financial instruments, junk bonds are potentially high-yield but come at a very high risk. Junk bonds are issued by companies with poor credit ratings or are experiencing financial hardship. As such, yield-to-maturity rates are often higher, but there is a risk that the company will not be able to meet the bond’s requirements.
Bonds vs stocks: What’s the difference?
Companies may either issue bonds or stocks when they need to raise capital. But what’s the difference for investors?
Primarily, a bondholder is effectively lending capital to the company. A stockholder, however, is purchasing a share of the company. An investor that buys a bond is paid in interest, while an investor who buys a share is paid a dividend in line with the company’s profits. As the company’s profitability rises and falls, so does the value of the investor’s stake.
Bonds vs loans
Bonds are often used to generate capital alongside other debt instruments like loans. Bonds are often seen as advantageous because the company can use the money in its operations however it sees fit, without the restrictions and conditions often stipulated by banks when issuing loans.
Frequently asked questions about corporate bonds
What are bond funds?
Bond funds are pools of capital from multiple investors that are invested in different types of bonds. A bond fund will often contain a combination of corporate, government and municipal bonds. Bond funds are professionally managed and tailored to meet investors’ specific goals.
What are callable bonds?
Callable bonds (also known as redeemable bonds) can be redeemed by the issuer before they have reached their maturity date. Issuers may do this if market interest rates fall and it is cheaper to pay off their debt early and re-borrow.