Why do Companies Issue Bonds?
Issuing bonds is a very common method of obtaining funding. Many large companies would not be able to expand their business or maintain the cash flow requirements of their operations if they could not access the corporate bond market for capital. The word "bond" usually refers to a loan of more than one year, but corporations can also issue shorter term debt, so corporate debt in general is often referred to as "corporate paper."
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Significance
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The corporate bond market is one of the largest debt markets on the planet, larger than municipal and Treasury markets. Not only does it generally help large corporations meet their capital needs, it also provides investors with a broad range of opportunity, with access to a variety of debt structure, maturity dates, credit quality and industry exposure.
Features
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Corporate bonds are usually issued in denominations of $1000 or $5000. The maturity, or the date at which the principal of the bond is due from the company, can vary from as little as thirty days to as long as thirty years. Most, but not all bonds offer what's called a "coupon," or periodic interest payments until maturity. Some bond may be callable, which means the company can pay off the principal and retire the debt before the maturity date.
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Types
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Corporate bonds can be of several different types. Secured debt is issued against specific collateral, whereas unsecured debt rests upon the company's general ability to make good on its obligations. Senior debt is the first to be paid off in the event the company faces bankruptcy or insolvency. Holders of subordinated debt are made whole after senior debt holders but before common shareholders.
Considerations
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Corporations have a higher risk of default than the US government, so investors seek a higher yield than on Treasuries of the same maturity. Corporate bonds therefore trade at a discount, resulting in a higher interest rate return, called the spread. AAA rated corporate bonds have the lowest default risk and therefore the smallest spread. Junk bonds and other high-yield assets are more risky and therefore carry a larger spread.
Warning
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The greatest risk associated with corporate bonds is credit risk, or the possibility the company is unable to pay its creditors. Depending on debt structure and the specifics of the company, credit risk could result in a bondholder receiving less than the full face value of their holdings. Less important, particularly if bonds are being held to maturity, is interest rate risk. Bonds go up in value as interest rates decline, so changes in interest rates can affect the value that can be obtained by liquidating a bond position prior to maturity.
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