Corporate bonds

Corporate bonds are debt securities often popular with longer-term investors. Learn everything you need to know about these types of business bonds, including the different types, how the corporate bond market works, and how to invest in them.

What are corporate bonds?

Corporate bonds are investment products issued by a company. The proceeds raised by issuing bonds are typically used by the company to refinance existing debt, to invest in their business such as buying new equipment or hiring more staff, or to help fund an acquisition or merger.

When you buy a corporate bond, you’re lending a company money until the maturity date, in return for a payment of interest (called the coupon). Like gilts, the coupon on corporate bonds is usually paid twice a year. At the maturity date, you should receive back the value of your bonds based on the original issue price.

What are the different types of corporate bonds?

Corporate bonds can be split into short, medium and long-dated groups – depending on the time between issue and maturity.

The safest type of corporate bond is called ‘investment grade’. Conversely, those at the top end of the corporate bond risk scale are called ‘junk bonds’ (high-yield corporate bonds). Although junk bonds might pay a much higher coupon, there’s a greater risk that the company issuing these bonds defaults – meaning you’d lose future interest payments and even your initial investment if the issuer gets into trouble.

Permanent interest-bearing shares (PIBs) are a type of fixed-interest investment issued by building societies. Like bonds, they pay a fixed amount of interest, but unlike bonds, they don’t have a fixed redemption date. The issuer also has the option to buy (or call) them back at certain times. As a result, PIBs can be harder to sell on, and are often seen as higher risk than other types of bonds.

Why do people invest in corporate bonds?

Investors looking for income can invest in corporate debt to plan a predictable stream of income over time. Other investors might buy corporate bonds to sell them for a profit on the secondary market. Although it can be very difficult to predict, the potential for return is strongest when interest rates are relatively high but expected to fall.

Investing in bonds is generally considered safer than individual shares. Providing the company whose bond you hold remains solvent, you should continue to receive their regular interest over time – plus the value of the bond based on the original issue price when it matures.

By contrast, the dividends you receive when you hold a share depend on the profits and investment strategy of the company. So, they could be reduced or cut altogether.

What are the risks?

The main risks associated with corporate bonds are the following:

• Default risk (when the company issuing the bond becomes insolvent);
• Inflation risk;
• And the risk that interest rates will rise over time.

Corporate bonds typically come with more risks than bonds issued by the government of a stable, developed country. But on the flipside, the coupon offered (and the potential yield) can be higher as a result. You can read more on this topic below.