Corporate Bonds: Definition and How They're Bought and Sold

James Chen, CMT is an expert trader, investment adviser, and global market strategist.

Ariel Courage is an experienced editor, researcher, and former fact-checker. She has performed editing and fact-checking work for several leading finance publications, including The Motley Fool and Passport to Wall Street.

Introduction to Fixed Income

1. Guide to Fixed Income: Types and How to Invest
2. The Basics Of Bonds
3. Fixed-Income Security
4. What Is a Fixed-Rate Bond?
5. Interest Rates, Inflation, And Bonds

Types of Fixed Income

1. Government Bond
2. Treasury Bond (T-Bond)
3. Bonds vs. Notes vs. Bills
4. Treasury Inflation-Protected Securities (TIPS)
5. Municipal Bond
6. Corporate Bond

Understanding Fixed Income

1. Bond Market vs. Stock Market
2. Equity Market vs. Fixed-Income Market
3. Cash vs. Bonds
4. Money Market vs. Short-Term Bonds
5. The Secondary Market: "Over the Counter"
6. Zero-coupon Bond vs. a Regular Bond

Fixed Income Investing

1. How Bond Market Pricing Works
2. Creating a Modern Fixed-Income Portfolio
3. Whereto Buy Government Bonds
4. Treasury Bonds and Retirement

Risks and Considerations

1. 7 Common Bond-Buying Mistakes
2. Interest Rate Risk
3. Pros and Cons of Inflation-Linked Bonds

What Are Corporate Bonds?

Corporate bonds are debt securities issued by a corporation in order to raise money to grow the business, pay bills, make capital improvements, make acquisitions, and for other business needs.

Bonds are sold to investors and the company gets the capital it needs and in return, the investor is paid a pre-established number of interest payments at either a fixed or variable interest rate. When the bond expires, or "reaches maturity," the payments cease and the original investment is returned.

The backing for the bond is generally the ability of the company to repay, which depends on its prospects for future revenues and profitability. In some cases, the company's physical assets may be used as collateral.

Key Takeaways

• A corporate bond is debt issued by a company in order for it to raise capital.
• An investor who buys a corporate bond is effectively lending money to the company in return for a series of interest payments, but these bonds may also actively trade on the secondary market.
• Corporate bonds are typically seen as somewhat riskier than U.S. government bonds, so they usually have higher interest rates to compensate for this additional risk.
• The highest quality (and safest, lower yielding) bonds are commonly referred to as "Triple-A" bonds, while the least creditworthy are termed "junk".

Understanding Corporate Bonds

In the investment hierarchy, high-quality corporate bonds are considered a relatively safe and conservative investment. Investors building balanced portfolios often add bonds in order to offset riskier investments such as growth stocks.

Over a lifetime, these investors tend to add more bonds and fewer risky investments in order to safeguard their accumulated capital. Retirees often invest a larger portion of their assets in bonds in order to establish a reliable income supplement.

In general, corporate bonds are considered to have a higher risk than U.S. government bonds. As a result, interest rates are almost always higher on corporate bonds, even for companies with top-flight credit quality. The difference between the yields on highly-rated corporate bonds and U.S. Treasuries is called the credit spread.

Corporate Bond Ratings

Before being issued to investors, bonds are reviewed for the creditworthiness of the issuer by one or more of three U.S. rating agencies: Standard & Poor's Global Ratings, Moody's Investor Services, and Fitch Ratings.

Each has its own ranking system, but the highest-rated bonds are commonly referred to as "Triple-A" rated bonds. The lowest-rated corporate bonds are called high-yield bonds due to the greater interest rate applied to compensate for their higher risk. These are also known as "junk" bonds.

Bond ratings are vital to alerting investors to the quality and stability of the bond in question. These ratings consequently greatly influence interest rates, investment appetite, and bond pricing.

Companies with solvency problems, those trying to avoid bankruptcy, and those in reorganization might also offer income bonds, usually at an above-average rate. Income bonds can raise money for the struggling company and are not required to pay coupons or dividend payments.

How Corporate Bonds Are Sold

Corporate bonds are issued in blocks of $1,000 in face or par value. Almost all have a standard coupon payment structure. Typically a corporate issuer will enlist the help of an investment bank to underwrite and market the bond offering to investors.

The investor receives regular interest payments from the issuer until the bond matures. At that point, the investor reclaims the face value of the bond. The bonds may have a fixed interest rate or a rate that floats according to the movements of a particular economic indicator.

Corporate bonds sometimes have call provisions to allow for early prepayment if prevailing interest rates change so dramatically that the company deems it can do better by issuing a new bond.

Investors may also opt to sell bonds before they mature. If a bond is sold, the owner gets less than face value. The amount it is worth is determined primarily by the number of payments that still are due before the bond matures.

Investors may also gain access to corporate bonds by investing in any number of bond-focused mutual funds or ETFs.

Why Corporations Sell Bonds

Corporate bonds are a form of debt financing. They are a major source of capital for many businesses, along with equity, bank loans, and lines of credit. They often are issued to provide the ready cash for a particular project the company wants to undertake.

Debt financing is sometimes preferable to issuing stock (equity financing) because it is typically cheaper for the borrowing firm and does not entail giving up any ownership stake or control in the company.

Generally speaking, a company needs to have consistent earnings potential to be able to offer debt securities to the public at a favorable coupon rate. If a company's perceived credit quality is higher, it can issue more debt at lower rates.

When a corporation needs a very short-term capital boost, it may sell commercial paper, which is similar to a bond but typically matures in 270 days or less.

A balanced portfolio may contain some bonds to offset riskier investments. The percentage devoted to bonds may grow as the investor approaches retirement.

Corporate Bonds vs. Stocks

An investor who buys a corporate bond is lending money to the company. An investor who buys stock is buying an ownership share of the company.

The value of a stock rises and falls, and the investor's stake rises or falls with it. The investor may make money by selling the stock when it reaches a higher price, by collecting dividends paid by the company, or both.

By investing in bonds, an investor is paid in interest rather than profits. The original investment can only be at risk if the company collapses. One important difference is that even a bankrupt company must pay its bondholders and other creditors first. Stock owners may be reimbursed for their losses only after all of those debts are paid in full.

Companies may also issue convertible bonds, which are able to be turned into shares of the company if certain conditions are met.

Are Corporate Bonds Better Than Treasury Bonds?

Whether corporate bonds are better than Treasury bonds will depend on the investor's financial profile and risk tolerance. Corporate bonds tend to pay higher interest rates because they carry more risk than government bonds. Corporations may be more likely to default than the U.S. government, hence the higher risk. Companies that have low-risk profiles will have bonds with lower rates than companies with higher-risk profiles.

Do Corporate Bonds Pay Monthly?

Most corporate bonds pay semi-annually; every six months; however, bonds can pay monthly, quarterly, or annually.

Are Corporate Bonds FDIC Insured?

No, corporate bonds are not FDIC insured. They are an investment security rather than a deposit of your funds, hence, they are not FDIC insured like your checking account is.

The Bottom Line

Companies need money to run their businesses. Even if they generate enough money through their core operations, it can be financially prudent to raise outside money. Companies generally have two options of doing this: equity financing and debt financing.

Equity financing is the issuance of stocks and debt financing includes the issuance of bonds. Corporate bonds allow companies to raise capital without giving up ownership and to operate more freely.

1. Fitch Ratings. "Rating Definitions."
2. Moody's. "Rating Scale and Definitions," Page 1.
3. S&P Global. "S&P Global Ratings Definitions."

Introduction to Fixed Income

1. Guide to Fixed Income: Types and How to Invest
2. The Basics Of Bonds
3. Fixed-Income Security
4. What Is a Fixed-Rate Bond?
5. Interest Rates, Inflation, And Bonds

Types of Fixed Income

1. Government Bond
2. Treasury Bond (T-Bond)
3. Bonds vs. Notes vs. Bills
4. Treasury Inflation-Protected Securities (TIPS)
5. Municipal Bond
6. Corporate Bond

Understanding Fixed Income

1. Bond Market vs. Stock Market
2. Equity Market vs. Fixed-Income Market
3. Cash vs. Bonds
4. Money Market vs. Short-Term Bonds
5. The Secondary Market: "Over the Counter"
6. Zero-coupon Bond vs. a Regular Bond

Fixed Income Investing

1. How Bond Market Pricing Works
2. Creating a Modern Fixed-Income Portfolio
3. Whereto Buy Government Bonds
4. Treasury Bonds and Retirement

Risks and Considerations

1. 7 Common Bond-Buying Mistakes
2. Interest Rate Risk
3. Pros and Cons of Inflation-Linked Bonds

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A yield spread is the net difference between two interest bearing instruments, expressed in terms of percent or basis points (bps).

A bond ladder is a portfolio of fixed-income securities with different maturity dates. Read how to use bond ladders to create steady cash flow.

A payment-in-kind bond is a type of bond that pays interest in additional bonds rather than in cash. PIK bonds are typically issued by companies facing financial distress.

A Treasury Bill, or T-bill, is a short-term debt obligation issued by the U.S. Treasury and backed by the U.S. government with a maturity of one year or less

Price value of a basis point (PVBP) is a measure used to describe how a basis point change in yield affects the price of a bond.

A war bond is is a form of government debt that seeks to raise capital from the public to fund war efforts.

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