Corporate bond issues provide a fixed-income investment alternative to municipal and US treasury bonds. Investing in corporate bonds carry a slightly higher credit risk than US treasury instruments, which require the company issuer to pay higher yields to their investors to reach borrowing goals. Bond yields should be benchmarked against US treasury yields and other corporate bonds with a similar credit profile. Not all corporate bonds are advisable, especially ones from companies known to have recent financial distress or those who have ever defaulted in the past. Extra consideration should also be given to the number of shares outstanding on any previous bond sales.
Companies are given daily credit ratings by Moody’s, Fitch and S&P (Standard & Poors). Check these ratings, and check the historical credit rating performance before investing in corporate bonds. The best corporate bonds are highly traded, and well-documented debt instruments. Also pay attention to mergers and acquisitions by industry or company. When a company merges with or acquires another company, any debt becomes a shared liability of the newly formed entity—a major factor in credit risk.
Corporate bonds can have mid-term and long-term investment options, 5 years or more than 10 years, and can be used effectively in fixed-income asset allocation. However, this long-term investment planning approach is only feasible for “non-callable” bonds. Callable bonds have a provision that gives the issuer (company) the right to “call”, or buyback the bond at a predetermined price once it reaches a minimum aging date. The corporation pays the holder any interest owed on the bond to date along with the outstanding principal balance. Callable bonds pay an interest premium over ‘vanilla’ bonds that expire only at maturity.
Most investments in this bond type comes from institutional investors. They are finance companies in the business of trading stocks and bonds on a large scale, oftentimes managing pools of capital for 1000s of investors or more. The investors are other corporations, brokers, and private investors too. As a Securities Pricing Analyst, I observed broker-dealers frequently use their corporate bond positions to collateralize and borrow cash for trading activities. To note, this financing approach only worked effectively because they held highly-traded corporate bonds from issuers with strong credit ratings which ultimately kept borrowing costs low.