Corporate Bonds Definition

Corporate Bonds Definition
Global business strategy

Corporate bondis a form of debt security issued by private as also public companies. The fund raised through Corporate Bonds is used meet the long-term financial need of the companies, such as business expansion, purchase of fixed assets, etc. The debt financing through Corporate Bonds include the following:

The buyer of the bond is the one who lendsthe money – Lender;

The corporation that issues the bonds to raise capital – Issuer/ Borrower;

The corporation promises to return the borrowed amount – Principal;

The Corporation pays interest on the Principal until its maturity – Coupon Rate.

It is to be noted that for issuance of corporate bonds, it is essential that the issuer/ borrower have strong credit worthiness. This helps the borrower to achieve larger amount of debt at a comparatively lower coupon rate.

Corporate Bonds – Better Source of Finance

Following are the potential reasons for which the corporate bonds may be considered a suitable source of finance:

  • Corporate Bonds allows the investors to invest in the company without diluting itsownership, as is the case with equity financing;
  • Loans availed through banks are generally rigid and comparatively less favorable to the borrowers. This is because the banks always play safe. The banks would never contract a fixed interest payment for a longer period of time because of the unforeseen losses that may occur in the future. This however, is not the case with issue of corporate bonds; and
  • Corporate Bonds can be issued directly to the investors without imposition of banks as intermediaries. This makes the borrowing process comparatively seamless and less expensive.

Corporation Bonds – Its Type 

There are a variety of Corporate Bonds based on numerous terms, structure and risk. Corporate Bonds generally vary due to features such as seniority, security, guarantee, convertibility, credibility, interest rate, etc.

Let us know each of the types of bonds in details:

Senior Bonds: This type of bond is senior in nature, i.e., the investors of this bond are given first priority over other lenders to claim on company’s assets given the company goes bankrupt. Given the comfort to the investors over other lenders, this bond generally carries lower coupon rate.

Subordinated Bonds: Subordinated bonds are the opposite of senior bonds in terms of it nature. The investors of this bond are considered last of all for claim on company’s assets given the company goes bankrupt. Given the risk to the investors over other lenders, this bond generally carries higher coupon rate compared to senior bonds.

Secured Bonds:As the name suggest, this type of bond is secured in nature. The security for the investor in this bond is company’s property. In the event of unforeseen insolvency, the investors can take charge of the company’s assets and relieve themselves of the loss to the extent possible. The secured bonds can also be senior in nature, which means that the investors stand ahead of other secured lenders for any repayment or claim at the time of liquidation. Given the comfort of security to the investors over other lenders, this bond generally carries lower coupon rate.

Unsecured Bonds: Unsecured bonds are not backed by company’s property. So the investors of this bond are exposed to the risk of loss from insolvency. The unsecured bonds can also be senior in nature. This seniority provides comfort to the investor by allowing them to stand ahead of other subordinated unsecured investors at the time of repayment or claim, if any. Given the risk to the investors over other lenders, this bond generally carries higher coupon rate compared to secured bonds.

Guaranteed Bonds: Guaranteed bonds are such bonds that provide guarantee for the financial obligations of the issuer. This means that in the event of default, the guaranteed company shall repay the borrowed amount to the investor. Similar to secured bonds, for the comfort of security to the investors over other lenders, this bond generally carries lower coupon rate.

Convertible Bonds:Convertible bonds give right to the investors to convert the bonds into common stock of the issuing company at any time during the life of the bond. This convertible feature let the investor enjoy both fixed interest payment as alsochance to avail the stock option in case ofshare price appreciation in the future.

Investment grade Bonds: This type of bond are safer to invest in as it carries higher credit rating [BBB-/ Baa3 or higher by S&P[1]/ Moody’s] indicating better creditworthiness of the borrower. As the chances of default for these bonds are very rare, they carry lower coupon rate.

Junk Bonds: Also known as non-investment grade bond, this bond holds lower credit rating [BB/ Ba or lower by S&P/ Moody’s]. Due to its poor credit profile, this bond carries higher risk and therefore, higher returns.

Bottom Line:

Based on the variety of corporate bonds available in the market, it is crucial to correctly decide the type of bond an investor wants to put it money into. Each bond type carries different risk-return profile and understanding the one that suits the most to an investor is often challenging. 

Maddox Smith

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