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Millions of individual and institutional investors around the world choose fixed-income securities, such as bonds, as their choice of investment. Bonds offer a stable and predictable yield and require little to no active management, which makes them extremely convenient for passive investors and large institutions.
However, not all bonds are equal and some offer much higher yields than others. The primary distinction between treasury bonds issued by governments and corporate bonds issued by companies is the factor of risk associated with them, as businesses tend to fail a lot more often than entire governments do, which is why the inherent risks must be accounted for by offering higher yields to prospective investors.
There are a number of different corporate bond structures on the market and coupon rates can vary greatly depending on the issuer and their financial standing/credit score. Investors can choose between anything from Coca-Cola bonds to junk bonds and fallen angels.
"Bonds as an asset class will always be needed, and not just by insurance companies and pension funds but by aging boomers." - Bill Gross
Choosing the right corporate bonds requires an understanding of the financial position of the company, which investors can review through the bond prospectus document, which highlights the financial performance, as well as key operational threats and opportunities for the company.
Before diving deeper into why companies issue bonds and how investors can use them to their advantage, it is important to understand the key concepts behind bonds in general, such as:
The world of corporate bonds is a diverse place, with offerings varying in maturity, par value, coupon, issuer, etc. Here are some common types of corporate bonds that are available for investment:
After you have done thorough due diligence and created a shortlist of bonds you are interested in, it could be time to consider the different methods of bond investing you can use to make sure you’re choosing the best possible route. Ways to invest in corporate bonds include:
"Simply put, investors should own less equities, more bonds, more global investments, more cash and more dry ammunition." - Mohamed El-Erian
You may be wondering what happens to your money if the company that has issued bonds goes bankrupt. The answer to this question depends on the type of bond you have invested in. There are two types of bonds in terms of priority, namely senior and subordinated:
Another way of determining the safety of your investment in the face of a company default is by looking at the security status of the bonds you would like to invest in. Typically, there are two types of corporate bonds in terms of security - secured and unsecured:
Investing in investment-grade corporate bonds can be a highly lucrative deal for most investors. Blue chip companies are characterized by stable performance, which is great for investors who expect higher yields than treasury securities.
A secured corporate bond is backed by real assets on the issuing company’s balance sheet, such as land, real estate, machinery, equipment, etc. The company may be forced to sell these assets in the case of bankruptcy to generate the necessary cash to pay back bondholders.
Corporate bonds are typically riskier than government bonds, as they carry inherent business-related risks that treasury securities do not have. Government bonds are backed by national budgets, which makes them much safer than corporate bonds and with a considerably lower yield as well.