CORPORATE BONDS

How does a bond work?

Institutions like the Federal Government, private companies and local governments, issue bonds as a type of “IOU” to borrow money to fund projects. Investors purchase bonds and in return, are guaranteed by the issuer some type of return rate for their investment.

Once the bond is purchased, the issuing agents take the money to use as they see fit. The investor then holds onto their bond until the maturity date and redeems it when the time has come.  Corporate bonds afford both investors and those seeking funding a grand opportunity to thrive, as investors make a profit from the lending, and the issuer gains spending freedom.

If you would like to diversify your portfolio by buying corporate bonds but aren’t sure about the investment strategy involved, review the following important points:

What is a Corporate Bond?

Corporate bonds are debt securities issued by corporations in order to raise money and expand business. The bond is basically an IOU from the corporation to investors and they are responsible for paying the loan back, including interest, by the maturity date. Essentially, the corporation is borrowing from corporate bond buyers and rewarding them for their risky investment with a high return.

The Risk of Corporate Bonds

When you have decided buying corporate bonds is for you, there are a few ways to go about it. The following is an outline of the steps you should take to purchase a corporate bond:

Step 1: Research Corporate Bonds

Review the ratings for the corporate bonds you are considering purchasing. The rating will give you an idea of how financially secure the corporation issuing the bond is. The higher the rating, the less risky the investment. Also, you can review corporate bond spreads to compare a bond’s risk and yield against other bonds.

A corporate bond spread is a comparison of corporate bonds with varying yields and degrees of risk. The spread is the difference between a corporate bond yield and that of a risk-free bond.

Corporate Bond Rates Vs. Treasury Bonds Interest Rates

A corporate bond yield is just about the most important number to consider when determining a bond’s potential earnings and weighing it against other investment options.You can use a simple formula to calculate the yield of a bond you currently own. Or, if you are comparing before buying corporate bonds, calculate the yield-to-maturity for its capability of earning more in the future.

The following are what you need to know about a bond in order to ascertain the yield:

If a corporation needs to raise money, it has the option of issuing a corporate bond. When you purchase a corporate bond, you are essentially granting that corporation a loan and it is backed only by their individual assets. In turn, you will be rewarded for your risky investment with a high interest rate.

Interest rates are not the only determining factor in how valuable a corporate bond may be, however. Review the following to better understand how corporate bond rates play into the overall value of a corporate bond:

Bonds are debt securities distributed by authorized issuers (business or government entities) that represent a debt owed by that issuer. Similar to a loan, a bond represents a formal contract between the issuer (debtor) and holder (lender), where which the holder gives money to the business to hold. After time has lapsed (i.e. the bond has matured), the issuer is obliged to pay interest (the coupon) and/or repay the principal. This occurs in fixed intervals over a period of time.

Bonds and often associated with stocks because they are both securities; however, there are a couple of major differences between the two. While bonds offer holders a creditor stake because they are lenders for the company, stockholders have an equity stake, meaning they are owners. Another difference is that bonds are based on a defined term (maturity) because since they are simply borrowing external funds to them to finance long-term investments. On the other hand, stocks are usually held indefinitely since the holder has a more permanent relationship as owner.

When you think of making investments, it’s hard not to think of the word bond as well. Along with stocks, bonds are probably one of the most well-known ways to invest money.

But what are they exactly? And how are they utilized to make investors money? We will explore the basics of the investment tool to help you in the event that you want to make this your next investing move.


The Definition of a Bond

A bond is a debt instrument issued by large companies and organizations in order to raise capital that can’t otherwise be borrowed from banking institutions. Because businesses need large amounts of money to operate, they borrow money from investors by issuing bonds. As a sort of “thank you” for the loan the investor provides, the business agrees to pay back the money with interest on a predetermined date.

Understanding bonds and bond prices is an essential aspect of making this type of investment. There are a number of elements to take into consideration when choosing bonds to purchase, but one that stands out is looking at what they are correlated to and how this affects your investment.

Making the Correlation


So if you’ve ever taken a look at bond prices, you probably have noticed that in a column nearby is mention of a yield. The yield represents the relationship between the bond’s dollar price and its cash flows (the interest payments and return on your principal amount that you receive throughout and at the end of your term, respectively). So basically, you’re looking at how the dollar is moving in relation to the type of returns you’ll gain for the term period you’ve agreed to.

When purchasing bonds, it is essential that as an investor you understand bond prices. And while the concept is not very simple to wrap your mind around, it cab be learned. So let’s explore what bond prices are and most importantly, what they mean to you as an investor.

Understanding Bond Prices

The first thing you should know about bond prices is that they mean much more than simply listing a rate related to your bonds. They actually go as far as to forecast future economic activity, as well as future interest rates. In other words, they’re pretty important. So how are bond prices determined? They represent a percentage of the bond’s principal balance (also known as par value or loan amount). So for instance, if you see a bond quoted at 99-29 ¾ for a two-year bond, and you were to buy a two-year $10,000 bond, you would pay a starting price of $9,992.97 to receive your full payout at the end of two years. The 99 in the number is called the “handle,” and the 29 ¾ is called the “32nds.” To figure how those numbers calculated your price, they must be converted into percentages. To do this, you would first divide the “32nd” value by 32 (29.75 / 32 = .9296875) then add the “handle” to this value. This equals 92.9296875%, which would then be multiplied by $10,000 to make $9,992.96875, or $9,992.97.