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What is a corporate bond?

 A corporate bond is a loan that investors make to a company, for a fixed period, secured against specific company assets. In return for that loan, the company promises to pay interest to the bondholder, generally at a fixed rate (called the coupon rate) on a regular payment schedule. A debenture is a similar corporate debt instrument, but the company has not assigned any specific assets as security for the loan.

Some corporate bonds have sinking funds that require the company to retire a certain number of bonds at regular intervals by buying them back from investors in the open market. In addition, a bond may be retractable or redeemable  / callable . 

What risks do they have?

Corporate bonds are low to high risk investments, depending on the strength of the company. The riskier the company, the more interest the company will pay you, but the greater the chance you will not get back the amount you invested. Junk bonds are the bonds of the riskiest companies.

The main risk of a corporate bond is that the company will fail to make interest payments and will be unable to repay the principal when it comes due.
 

You can use a credit rating agency's rating of a company to help you determine the risk of investing in that company's bonds. Credit rating agencies provide ratings that reflect the agency's assessment of the credit worthiness of companies that issue bonds. A company's credit worthiness or rating is an assessment of the likelihood that the company will be able to pay interest and principal of a bond.

Another significant risk is that some corporate bonds are redeemable or callable. This means the company can require you to sell the bond back at face value before the maturity date. This can happen when interest rates drop and the bonds you are holding pay a higher rate of interest than the current interest rate. If this happens, you may be unable to find an equally attractive investment.

Given that the price of previously issued corporate bonds fall as interest rates rise, there is a risk that inflation may rise faster than the bond’s yield.

One way to reduce the interest risk and reinvestment risk is to purchase bonds with various maturity dates, known as a bond ladder.

Can you sell them easily?

Possibly. The company that issued the bond will generally not buy it back from you before its maturity date, and most corporate bonds do not trade on an exchange. Instead, your advisor must try to find a buyer for your bond in the over-the-counter market. It’s easier to sell bonds if they are widely followed or highly rated.  In these cases, your advisor will likely be able to find a buyer in the over-the-counter market.

You should talk to your advisor if you are thinking of selling a corporate bond before its maturity date. If interest rates have risen, you may lose money.

What are the costs?

Generally, your advisor will sell you a bond from the firm’s inventory. If so, the price will contain a mark-up to cover the costs of your advisor’s firm. Go to the government bonds page for a discussion of bond pricing.  If the advisor is acting as your agent and finding a bond in the over-the-counter market, you may also have to pay a commission.

What are the expected types of returns?

Corporate bonds pay interest, usually more than GICs and government bonds. Normally, bonds with longer maturity dates come with higher interest rates. Weaker companies need to offer higher rates to cover the risk that the company will be unable to repay the principal (and may not even exist) when the bond matures.

The company sets interest rates for the bond’s term. Assuming the company continues to be able to pay back its debt, you will receive interest on a regular basis, usually every 6 or 12 months, until the bond matures.