Corporate bonds are securities that companies sell to raise funds. These should not be confused with government bonds, which are less risky and tend to have lower rates of return. Corporate bonds are a type of debt: investors loan a particular amount of money to the company and in return acquire the ability to demand payment for the bond after it matures, including profit made from the bond's interest rate. Corporate bond terms and rates differ based on decisions made by the companies and market conditions.
Rate of Return
A rate of return refers to the interest rate of the bond, the rate applied to the bond's principle over the years as it matures, gradually adding value that the investor holding the bond is owed. The expected rate of return is simple: how much profit the investor expects to make by lending out money on a bond; the higher the rate of return, the more the investor will be willing to pay for the bond. Rates of return are influenced by other interest rates, inflation and company strategy. A common rate of return for business bonds is around five percent for a 30-year bond, but this can vary according to many actions.
External Rate Factors
Bond rates of return are affected by all interest rates. A company will offer a rate of return that the market is willing to accept, but not one so high that it will struggle to meet its debts in the coming years. Average interests rates are one of the primary factors, and these are controlled by the Fed and Treasury through money supply controls and government bond rates. When the government is lowering interest rates by lowering its bond rates, then corporate bond rates will fall, too. Inflation also reduces the value of bonds, so investors interested in a real rate of return will often deduct inflation percentages based on how long the bond lasts.
Company plans change bond rates of return, too. Companies create bonds primarily so they can borrower money to invest in projects. Their investments also produce rates of return. Companies conduct analysis to ensure that the rates of return they offer will not exceed the rates of return they will make. For instance, if a company expects a 10 percent rate of return on a project, it will have no problem issuing a 5 percent bond, but if the expected rated of return for the company is only 5 percent, the business will issue bonds well below that.
Bond values themselves change according to the bond market, which can affect the profit investors can make selling the bond. For instance, if bond rates of return are currently falling, then older bonds with higher rates are worth more, so they increase in value on the market and make investors more profit through selling the bond. But if bond rates are rising, then the market value of older bonds fall, and investors tend to hold onto them rather than sell them at a discount.