How Do Corporate Bonds Work?

What are Corporate Bonds?

A bond is an investment that is a debt instrument, meaning that the bond issuer borrows a specified amount of money from you, often in multiples of $1,000. The bond issuer pays the bond holder interest payments on the debt until the date of maturity, when the investor cashes in the bond and receives the face value of the bond back.
In some cases, the issuer can pay the debt back early if they want to. This is called a callable bond. Corporate bonds are issued by corporations to raise capital to start up or expand their business. Corporate bonds can either be short term, which mature in less than a year, or long term, which have maturity dates longer than 1 year.

When bonds are first issued, investors buy directly from the corporation that is looking to raise capital by selling bonds. Once the bond is first issued, the bond can be sold and resold on the bond market until the date it matures. These transactions are usually handled by a financial advisor or financial services company that allows you to conduct your own trades, such as Ameritrade.

If a bond is purchased at face value, it is purchased at par. The face value refers to the dollar amount the bond was issued for, which is written on the certificate. This is the amount the bond holder will receive when the corporation pays back the debt, either when the bond matures or the corporation calls the bond. If the issuer defaults on the loan, the bond holder is out his investment. Bonds can often be purchased at a discount, meaning the investor pays less for the bond than is on the face. If the bond buyer pays more than the face value, that is called paying a premium. This is usually only done if the interest rate is particularly high. However, the bond holder always receives the face value at the date of maturity. If the bond is called before the date of maturity, the investor may receive a small bonus. The maturity date is set by the issuer when the bond is issued.

The coupon rate of a corporate bond is the annual interest rate the issuer will be paying the bond holder. A high coupon rate is desirable for investors, because the higher the coupon rate stated on the bond, the higher the interest payments the bond holder will receive. The bond issuer sets the coupon rate when the bond is issued. The rate generally stays the same until the date of maturity. The interest is paid monthly or quarterly on some bonds, but most are paid semiannually.

Corporate bonds, like any investment, vary in the amount of safety they offer the investor, and nothing is guaranteed. The corporation issuing the bond guarantees the bond, but the safety of the investment depends on the credit worthiness of the corporation. However, bonds are safer than stocks, because debtors are paid before stock holders in the event the corporation goes out of business. Corporate bonds are not considered to be as save as municipal bonds, because the chance of default is higher. A good way to determine whether a bond is a safe investment is to look at the bond rating. If a bond is rated as BBB, Baa or higher, the bond is usually considered to be a sound investment. AAA-rated bonds are fully insured by whoever is issuing the bond, making them very safe.