More and more people are considering using bonds for investing in retirement accounts. Before you make any commitments, take time to understand exactly how cooperate bonds work, the benefits they offer and the restrictions associated with them.
Corporate Bonds are debt instruments issued by business’s 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 normally 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 time periods such as 90 days. Commercial paper is normally an IOU issued by the corporation to finance short term needs.
Debentures or Corporate Notes:These bonds or notes are not secured by any assets. The only guarantee is the credit worthiness of the issuer. These notes would typically pay a 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 prior to the maturity date. If a corporate bond had a maturity date of 30 years it would normally 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 being paid on the bond, the corporation will not call the bond.
Put Feature: This allows the bond holder 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 insure the bond will be redeemed as agreed.
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 effect the value of a bond. A bond sold prior to the maturity date may not have the same value because of outside influences such as higher interest rates.
Corporate bonds are used because most are a higher arte 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.