When you buy a bond, you lend money to the issuing entity, which promises to repay the face value along with interest over time. This makes bonds akin to an IOU.
Bonds come in various forms, including U.S. government securities, municipals, mortgage-backed, foreign bonds, and corporate bonds. In a diversified investment portfolio, highly-rated corporate bonds can help accumulate wealth for retirement, education, or emergencies. Investors can access these via online brokers.
Key Takeaways
- Corporate bonds are issued by companies seeking to raise cash.
- Purchase bonds on the primary market through brokers or banks.
- Some corporate bonds trade on the over-the-counter market, offering good liquidity.
- Understand bond pricing, associated risks, and interest payments before investing.
What Is a Corporate Bond?
Corporate bonds are issued by companies to access cash without diluting ownership or taking loans. Funds raised may be used for assets, research, refinancing, or acquisitions.
A corporate bond operates like an IOU: the issuer promises to repay the face value plus interest at regular intervals.
Investing in bond funds or index funds tied to a basket of bonds is another option for exposure.
Buying and Selling Bonds
Buying bonds is straightforward, similar to investing in stocks. Purchase in the primary market through brokers, banks, or bond traders, who charge commissions. Prices are quoted as a percentage of face value; for example, a bond priced at 95 costs 95% of its face value.
Some corporate bonds trade on the over-the-counter market, providing good liquidity for active investors.
Key Characteristics of Bonds
Corporate bonds can generate reliable income, but understanding key characteristics is crucial.
Ratings and Risk
Bond ratings from agencies like Standard & Poor’s and Moody’s assess financial stability and default risk. Investment-grade bonds (rated AAA to BBB) are safer, while junk bonds (BB or below) carry higher risk but offer greater yields.
Bond Prices and Interest Payments
Bond prices fluctuate, affecting interest rates. When prices decline, yields increase. Long-term bonds typically pay higher interest due to associated risks. Callable bonds can be redeemed early by the issuer, which may result in lost interest.
Interest on bonds is usually paid semiannually. Riskier bonds generally provide higher returns to attract investors but are less reliable.
The Bottom Line
A well-diversified portfolio should include highly-rated corporate bonds of various maturities. While no investment is risk-free, quality corporate bonds can provide a steady income stream.
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