Corporate Notes and Bonds
Public or private corporations and organizations issue corporate bonds for the purpose of funding capital improvements, expansions, acquisitions or debt refinancing. Investors essentially are lending money to the issuer.
The issuer agrees to make fixed-interest payments and repay the principal at maturity. Unlike stocks, corporate bonds do not give ownership interest in that corporation. Investors are securitized by either corporate assets and/or real estate holdings. They become a general creditor of the issuer.
Corporate bond offerings are evaluated by the key credit rating agencies. They take into consideration the corporation's financial status, resources and competitive position within their industry. For a bond to make investment grade, it must have a minimum rating of Baa from Moody's and BBB from Standard & Poor's (S&P).
| Credit Ratings | Moody's | S&P | Fitch |
|---|---|---|---|
| Prime | Aaa | AAA | AAA |
| Excellent | Aa | AA | AA |
| Upper Medium | A | A | A |
| Lower Medium | Baa | BBB | BBB |
| Speculative | Ba | BB | BB |
| Very Speculative | B, Caa | B, CCC, CC, C | B, CCC, CC, C |
| Default | Ca, C | D | DDD, DD, D |
Corporate bonds are issued by industrial corporations, financial service corporations, public utilities, transportation corporations and conglomerates.
Types of Corporate Bonds:
Fixed-Rates
An issuer borrows money from an investor and agrees to make semi-annual interest payments at a fixed rate and pays back the principal amount at maturity.
Zero Coupons
Zero coupons are sold at a discount from par and receive a yield that is the difference between the purchase price and the face value price at the maturity. They are taxed annually, even though the full value and accrued interest is paid at maturity.
Floating-Rates
Floating-rate securities have variable interest rates that are adjusted periodically according to the pre-determined index with which they are associated. Some are indexed from short-term Treasuries and other money markets. Yields are typically lower than other fixed-income products with the same maturity because they offer protection against increased interest rates. The rate can be readjusted more than once annually.
Callables
Callable bonds have a provision where the issuer has the right to call back the security on a certain set day before maturity. This can be a disadvantage for the investor in a declining interest rate market. The investor loses the higher interest rate and the issuer can reissue that outstanding debt with a lower rate bond. The investor now has to reinvest at lower interest rates, resulting in lower yields. Because of this, callable bonds carry a higher interest rate.
Puttable Bonds
These bonds are similar to callable bonds. However, with puttable bonds, it is the investor who has the right to call the bond before its maturity date. You can 'put' the bond back to the issuer for the par value plus accrued interest at pre-determined intervals at your discretion. They usually yield lower rates than a comparable bond.
Step-Up Bonds
The investor receives a fixed rate of interest until a pre-determined date. Then the coupon increases if the issuer does not call the bond.
Safety
The corporate bond market is broad and liquid, with more than $1.52 trillion issued in 2016* alone.
A fairly liquid secondary market allows investors to sell or trade their securities at market price.
The market price is dependent upon the fluctuation of interest rates, as it is with any fixed-income investment. Depending on when you enter the market, your bonds may sell at par, at a premium or at a discount to their face value.
Yield
Corporate bonds generally offer higher yields than U.S. Treasuries.
Corporate bonds’ true value is in the yield spread over other investments they provide.
Depending on the terms, interest payments can be made monthly, quarterly or semi-annually.
Diversity
Corporate bonds offer short-term (up to five years), medium-term (five to 12 years) and long-term (more than 12 years) issues.
Corporate bonds are available in an assortment of credit qualities, maturities and coupon structures.
Some corporate securities are callable.
Limitations
Corporate bond interest payments are usually taxable by the federal and state governments.
Some corporate bonds are callable bonds.
A potential increase in the risk of default exists with corporate bonds when compared with U.S. Treasuries. Other possible types of risks, such as changes in corporate credit rating, a leveraged buyout or a weakening in the industry sector, may affect the market value.
* Securities Industry and Financial Markets Association (SIFMA), US Research Quarterly, Fourth Quarter 2016 (03.1.2017)