Corporate Bonds

Corporate bonds:

  Corporate bonds are very similar to preferred stocks in that they pay interest to the holder usually on a quarterly basis.  When you buy common stock you actually are buying a piece of that company but when you buy a bond you are actually loaning that company money.  It’s just like when you go to your local bank and borrow money.  In this case you are the bank and you are loaning money to a corporation and in return they will pay you interest payments.  It is very similar to you paying your bank payments on a loan.

 Bonds are rated and there are several rating systems.  The two most famous of the bond rating systems are S&P and Moody’s.    While the rating systems are slightly different, in general a rating of AAA would be the best AAB not quite as good and BBB is the lowest rating that is considered to be an investment grade bond. 

CCC and lower are junk bonds and while they pay very high interest rates, they are not safe.  Why?  The reason is that if the company was stable they could borrow money at a lower rate.  Issuing bonds at a high interest rate is done only as a last resort in most cases and there is a very high danger that companies issuing high yield bonds (also known as junk bonds) will go bankrupt and your bond will be worthless.  If you want to invest in junk bonds only do it in a junk bond fund that way your risk is spread out over thousands of bonds not just one or two and if a few of them go bankrupt you don’t lose everything as you would if you actually bought individual junk bonds. 

Most corporate bonds are not rated AAA, that rating is usually reserved for government backed bonds which corporate bonds are not.  If you chose bonds that are rated BBB and higher then you should be ok but as always there are no guarantees.  Bonds pay an interest rate currently somewhere between 3 and 7 percent with 4-5 being about the norm. 

Just like the preferred stock, as the price of the bond goes up the yield goes down and conversely as the price of the bond goes down the yield goes up.  However if you buy the bonds new and they pay 5% then your yield will always be 5% and it will never change.  Only when the bonds are resold at a higher or lower rate will the yield change. 

The face value of most bonds is $1000.00 when you buy them new.   Oddly enough when you see them listed in the newspaper the new bond would be listed as 100, but it means 1000.  That is a traditional holdover from an earlier time but you should be aware of that factor. 

Most bonds have a maturity date such as if you buy an XYZ company bond that matures in 2025, then in 2025 no matter what the bond has been selling for, it will be redeemed for the $1000.00 face value that you paid for it all those many long years ago.  Bonds can have “call provisions” which simply means if the economy and interest rates change the company has the right to give you your $1000.00 back in full along with any earned interest.  They would do this if interest rates went down and would call in 7% bonds to reissue 5% bonds, for example, as a cost savings for the company. 

There are two types of bonds a regular bond and a debenture.  The regular bond is backed by the assets of the company, so if they go bankrupt they must sell off their assets (forklifts, buildings, furniture, equipment) and give the bond holders some of that money (if there is any left after paying the creditors).  With a debenture you are only going with the full faith and credit of a company’s good name with no assets backing up the bond. 

One probably should not just buy one or two bonds.  If you hold one or two bonds then after one year you would have 50-100 dollars for all your trouble.  That’s not even a good night out on the town anymore.  When considering bond purchases buy 5 or 10 if you can or more and as always, diversify your investments by buying for example, 10 of Company A, 10 of Company B, 10 of Company C, and so on so that your money is invested at least in 3 or 4 different companies and use the bond rating system to help you select the right bonds for you. 

Copyright 2012 , Greg High , all rights reserved.