Corporate bonds: What they are and how they work

What are corporate bonds?

A corporate bond is a type of bond issued by a corporation. Buying a bond is basically extending a loan to a “borrower.” With corporate bonds, a company is borrowing money, usually a minimum of $5,000 and rising in $1,000 increments from there.

As with a loan, a corporate bond usually has a fixed interest rate, so you’ll receive set payments from the company, typically twice a year. The length of the loan can vary from one to 30 years, and at the end of that time period, the company pays you back the original face value of the loan.

Types of corporate bonds

As with other types of assets, you have options when it comes to the type of corporate bond you want. Each type has benefits and drawbacks, so compare your options before deciding which type of bond you’d like to buy.

• Fixed rate — Most corporate bonds are fixed-rate, which means the bond’s rate stays the same during the term. These types of bonds come with consistent payments at set intervals, typically one year, worth the fixed-rate percentage based on the value of the bond.
• Floating rate — A floating-rate bond will see rates on the bond change based on a predetermined benchmark. Rising rates could increase the bond rate and generate larger annual returns, while lowering rates could decrease your annual returns.
• Zero coupon — Zero-coupon bonds don’t pay any type of annual interest rate. However, these bonds are purchased at a discount, and the bond is repaid in full plus the interest rate at the end of the term.
• High yield — High-yield corporate bonds pay a higher interest rate but have a lower rating. Continue reading to learn more about the importance of a bond’s rating.
• Convertible — Convertible corporate bonds can be converted into a different type of asset, usually the corporation’s common stock.

Buying a bond is basically extending a loan to a “borrower.” With corporate bonds, a company is borrowing money (usually a minimum of $5,000 and going up in increments of $1,000 from there). Like a loan, a corporate bond usually has a fixed interest rate, so you'll receive set payments from the company, typically twice a year. The length of the loan can vary from one year up to 30, and at the end of that time period, the company pays you back the original face value of the loan.

Why consider corporate bonds?

Corporate bonds are considered a fixed-income type of investment. It's called fixed income because these kinds of investments are designed to pay investors a steady income.

Those payments can be used one of two ways:

1. Stream of income — Bonds can provide a predictable, steady stream of income when you retire, or anytime. They can be combined with other sources of income from pensions, Social Security or other investments.
2. Diversification — When used as part of a diversified portfolio, bonds can help smooth out your portfolio's returns. Over the long term, bonds have been less volatile than other types of investments, such as stocks.

Your financial advisor can help you find the right investment mix of stocks and bonds for your portfolio. It's based on your financial goals, risk tolerance and time horizon.

How corporate bonds work

Rating bonds that make the grade

Just like when you apply for a personal loan, a corporation has a credit rating that can help the lender — you — decide whether to issue the loan. The company's financial standing —its earnings and debts, the structure of its industry and the outlook for future profitability — determines its ability to make those regular payments.

Bond credit ratings look a lot like a school report card. Ranging from AAA to D, the more A's, the better. Generally, anything rated between AAA and BBB- is considered “investment grade,” although different ratings agencies have slightly different rating notations.

These ratings generally represent the rating company’s opinion of the bond’s ability to meet its ongoing contractual obligations. They are estimates and should be one of many factors in evaluating a fixed-income investment. These ratings should not be considered an indication of future performance. See Understanding Bond Credit Ratings for more information.

Interest rates

Similar to the stock market, the bond market can be unpredictable. At Edward Jones, we don't try to forecast exact interest rate movements. Instead, we use a strategy called “bond laddering” to prepare for potentially rising rates. Laddering means staggering the maturity dates of your fixed-income investments to own an appropriate mix of short-, intermediate- and long-term bonds.

Your corporate bond income will stay the same as long as you own the bond's, but your bonds' market value will vary. Bond prices and interest rates move in opposite directions. When interest rates rise, bond prices go down. The risk of this lowering of bond values as a result of rising rates is called "interest rate risk."

Edward Jones has a large inventory of corporate bonds, so your financial advisor can help you find bonds with varying maturities as you build your ladder. This will help you avoid playing guessing games with interest rates, and you'll have a more diversified portfolio, which helps lower your interest rate risk. You must evaluate whether a bond ladder and the securities held within it are consistent with your investment objectives, risk tolerance and financial circumstances.

Maturity

As with other types of bonds, corporate bonds come with a set term length known as the maturity. Corporate bonds can last for up to 30 years, but you can find shorter-term options from as little as one to two years. Investors who want a medium-term bond may opt for a bond with a five- or 10-year maturity. Choosing a mix of maturities could be a good way to diversify your bond mix, too.

Yield and market value may fluctuate if sold prior to maturity, and the amount you receive from the sale of these bonds may be less than the amount originally invested.

Corporate bond risks

As with all investments, corporate bonds do carry some risk. As mentioned earlier, rising interest rates can decrease the value of a corporate bond, while dropping interest rates can increase its value. Also, the bond issuer could default, meaning they would be unable to make payments on the bond. However, corporate bonds are considered to be a more conservative asset.

Corporate bonds could also include provisions that allow the corporate to redeem the bond early. Those who want to sell their corporate bond might find it difficult to sell on the secondary market.

Consider contacting a financial advisor to ensure you understand the risks of corporate bonds and find the best bond for your investment goals.

Current rates

Get up-to-date information on current bond, CD and money market rates. Learn more.

How we can help you buy corporate bonds

Your local Edward Jones financial advisor can help you find corporate bonds that fit your needs and your portfolio.