A corporate bond is a type of financial instrument issued by a company as a means of raising capital to facilitate its growing business goals. In corporate bonds, the company issuing the bonds is obligated legally to pay periodic interests to the bondholders and also pay the principal upon bond maturity. This article aims to information on how a bond works and how to invest in a corporate bond.
Key things about corporate bond
- The corporate bond allows an investor to lend money to a company to satisfy its needs, in return, the investor is paid a predetermined number of interest payments.
- The interest paid on a corporate bond is either fixed or variable(altered periodically with changes in the market).
- Upon expiration of a corporate bond, the interest payments paid by the company to the bondholder cease, and the principal amount paid initially is repaid to the investor.
- Corporate bonds can be traded on both the primary and secondary financial markets.
- Although corporate bond is considered to have a higher risk as a company may fail to make timely payments of interest still the higher interest rates which apply makes this investment option worth it.
How to invest in corporate bond
Investing in corporate bonds works just like other equity market financial instruments(stocks etc). To invest in a corporate bond, the investor makes a purchase from either a brokerage, firms, brokers, bond traders etc for a certain fee known as a commission for engaging the sale.
The bond prices are quoted as a percentage of the face value. This implies that a bond selling at 50 can be bought at 50% of its face value. A 100,000 naira bond would cost an investor 50,000.
Bonds can also be traded over the counter, this method offers liquidity(the ability to sell the bond for ready cash).
How to choose the right corporate bond
Are you looking for long-term or short-term investment? Would you prefer to be paid the interest payment once and in full?
Several types of corporate bonds exist and each differs in its terms.
- The primary classification of bonds depends on the date of maturity and they are short-term (less than 3 years), medium-term ( duration ranges from 4 to 10 years), and long-term ( more than 10 years ). Another important thing to know about the corporate bond is that the interest rates paid are subject to the duration of the bond. Long-term bonds, for instance, have a higher interest rate but it is also riskier.
- Corporate bonds are also categorized ba on their credit quality which considers the default risk of a bond(the likelihood of a company not making interest payments and returning capital). Here, we have investment grade bonds which are considered more likely to be paid on time and non-investment grade- which often have higher interest rates although it holds more default risk.
- Another way, bonds are categorized is based on interest rates. Fixed-rate bonds have a fixed interest throughout the duration of the bond purchased, whereas, floating rates can be readjusted periodically to market changes and prices for the bonds. Zero-coupon bonds pay no interest daily/monthly/yearly, but the total interest earned over time is paid as a single payment upon maturity together with the principal.
- Choosing the right corporate bond that works for you is dependent on your investment goals. It is necessary if investing in corporate bonds must be worth it.
Difference between Corporate bonds and stocks
Most people often confuse stocks with bonds but there exist differences between them.
Stocks allow stockholders to own a share of a company while also receiving a share of the company’s profits in the form of dividends(dividends are a share of a company’s profits paid by a company to its investors- stockholders ).
With corporate bonds, a bond holder does not own a share of a company but instead recieves interest for the principal on the bond. This implies that, no matter how profitable a company becomes, the company is only entitled to pay the interest stated and despite if the company goes bankrupt, it will still be obligated to pay the interest on the bond and also principal when due. Bondholders, have a higher claim to a company asset than share holders in the situation of a company’s bankruptcy.
Corporate bond is one of the profitable investments available in the financial market. The interest paid can be a convenient way of making more money and for those looking for a source of income- bond investing would sufficiently improvise. Still, the default risk of bonds can not be ignored, but in the long haul it will be worth the capital invested.