Corporate bonds are essentially IOU notes issued by a corporation in order to raise money to expand their business. The term usually refers to bonds that mature after a year or more. Bonds with a shorter maturity are usually called commercial papers.
The term "corporate bonds" is often used to describe any type of bond apart from those issued by national and state governments in their own currency. These bonds are usually referred to as being government bonds.
Corporate bonds are sometimes listed on major exchanges such as MarketAxess, and these bonds are called listed bonds. However, the vast majority of bonds are traded through smaller dealer based markets.
The interest on bonds is always expressed in currency, rather than percentage, terms as the rate is always fixed. This interest rate is known as the coupon rate. For example, a 100GBP bond might have a coupon rate of seven pounds, which is the equivalent of a fixed seven percent interest rate.
The coupon is almost always taxable, although you can claim this tax back if the investment is part of a stocks and shares ISA. In some instances, the coupon rate might be zero if the bond has a high redemption value and a very low investor risk.
There is an option with some bonds to redeem them before they mature. Bonds with this option are usually referred to as having an embedded call option. You can also get convertible bonds that give the investor the option of converting the bond into equity.
Compared to shares, corporate bonds provide a reasonably low investment risk. However, it is important to remember that there is always a risk, however small, of the bond-issuing company defaulting in the loan. As a rule, government bonds are less risky than corporate bonds.
As is the way with investments, the bigger the risk, the bigger the potential return, and corporate bonds are no different. The investment risk factor depends on the current state of the economic market, as well as the state of the company you are buying bonds from. A higher investment risk will usually result in a higher coupon rate.
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Renato Loehrer is very knowledgeable on savings and accounts and loves to write about corporate bonds.
