Corporate bonds can be a smart investment if you know all the details
More and more people are considering using bonds for investing in retirement accounts. Before you make any commitments, take time to understand precisely how corporate bonds work, the benefits they offer, and the restrictions associated with them.
Corporate Bonds are debt instruments issued by businesses to provide liquidity. The proceeds are often used to expand a business or to fund research for future product expansion. Corporate bonds will pay interest on a semi-annual or quarterly basis. Maturity dates (end of term) will typically be 20 years but can be longer. Often time corporate bonds are issued for 30 year time periods.
Types of Corporate Bonds
Mortgage Bonds: These are bonds secured or backed by a specific asset such as real estate. Because these are secured bonds, they often pay a lower interest rate.
Convertible Bonds: These are bonds that can be converted to a specific number of common stock. Those who invest in convertible bonds would expect a rise in common stock value.
Commercial Paper: Normally used for short periods such as 90 days. Commercial paper is usually an IOU issued by the corporation to finance short-term needs.
Debentures or Corporate Notes: Assets do not secure these bonds or notes. The only guarantee is the creditworthiness of the issuer. These notes would typically pay higher interest because they are not secured.
Corporate Bond Information and Features
Call Feature: Many corporate bonds will have a future call date, at which time the bond may be redeemed before the maturity date. If a corporate bond had a maturity date of 30 years, it would typically have a call date at the 10 year time period. If interest rates are lower in 10 years, the corporation will redeem the bond by issuing new bonds at a lower interest rate. If general interest rates are higher than the interest paid on the bond, the corporation will not call the bond.
Put Feature: This allows the bondholder to force the corporation to redeem the bond. This feature is not used often.
Sinking Fund: Some corporate bonds require the corporation to set aside funds to redeem future bond obligations. This is meant to be a safety feature to ensure the bond will be redeemed as agreed.
Income Tax
- Interest income and capital gains from corporate bonds is fully taxable
- Potential Risks in Corporate Bond Ownership
- Default: The bond issuer may not be able to pay the agreed-upon interest or redeem the value of the bond at maturity.
- Market: Changes in general interest rates can affect the value of a bond. A bond sold before the maturity date may not have the same value because of outside influences such as higher interest rates.
Investment
Corporate bonds are used because most are at a higher rate of return than municipal bonds. These bonds generally provide a safe and reliable income stream.
Tips Regarding Corporate Bonds
Always know the bond rating of the bond you are considering. There are numerous bond rating services available to provide this information.
If the bond has a call feature, find out if they will pay a premium to you if it is called.
Bonds are debt instruments; make certain you fully understand any risk you may be taking. Very high-interest rates can mean low security and safety.
