Companies issue corporate bonds (or corporates) to raise money for capital expenditures, operations and acquisitions. Corporates are issued by all types of businesses, and are segmented into major industry groups.
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Corporate bondholders receive the equivalent of an IOU from the issuer of the bond. But unlike equity stockholders, the bondholder doesn't receive any ownership rights in the corporation. However, in the event that the corporation falls into bankruptcy and is liquidated, bondholders are more likely than common stockholders to receive some of their investment back.
There are many types of corporate bonds, and investors have a wide-range of choices with respect to bond structures, coupon rates, maturity dates and credit quality, among other characteristics. Most corporate bonds are issued with maturities ranging from one to 30 years (short-term debt that matures in 270 days or less is called "commercial paper"). Bondholders generally receive regular, predetermined interest payments (the "coupon"), set when the bond is issued. Interest payments are subject to federal and state income taxes, and capital gains and losses on the sale of corporate bonds are taxed at the same short- and long-term rates (for bonds held for less, or for more, than one year) that apply when an investor sells stock.
Corporate bonds tend to be categorized as either investment grade or non-investment grade. Non-investment grade bonds are also referred to as "high yield" bonds because they tend to pay higher yields than Treasuries and investment-grade corporate bonds. However, with this higher yield comes a higher level of risk. High yield bonds also go by another name: junk bonds.
Most corporate bonds trade in the over-the-counter (OTC) market. The OTC market for corporates is decentralized, with bond dealers and brokers trading with each other around the country over the phone or electronically.
TRACE®—Bond Trade Reporting Comes of Age
TRACE, FINRA's over-the-counter real-time price dissemination service for the fixed income market, brings transparency to the corporate and agency bond markets. By distributing accurate and timely public transaction data, TRACE provides access to reliable fixed-income information, enhancing the integrity of the market.
Introduced in July 2002, TRACE consolidates transaction data for all eligible corporate bonds, and since March 1, 2010, for all U.S. agency debentures.
Since May 16, 2011, TRACE collects transactions in asset-backed and mortgage-backed securities, and since June 30, 2014, transactions executed pursuant to SEC Rule 144A also became subject to dissemination.
Access to real-time trade data through TRACE helps investors to better gauge the quality of the execution they are receiving from their broker-dealers.
There are two concepts that are important to understand with respect to corporate bonds. The first is that there are classifications of bonds based on a bond's relationship to a corporation's capital structure. This is important because where a bond structure ranks in terms of its claim on a company's assets determines which investors get paid first in the event a company has trouble meeting its financial obligations.
Secured Corporates: In this ranking structure, so-called senior secured debt is at the top of the list (senior refers to its place on the payout totem pole, not the age of the debt). Secured corporate bonds are backed by collateral that the issuer may sell to repay you if the bond defaults before, or at, maturity. For example, a bond might be backed by a specific factory or piece of industrial equipment.
Junior or Subordinated Bonds: Next on the payout hierarchy is unsecured debt—debt not secured by collateral, such as unsecured bonds. Unsecured bonds, called debentures, are backed only by the promise and good credit of the bond's issuer. Within unsecured debt is a category called subordinated debt—this is debt that gets paid only after higher-ranking debt gets paid. The more junior bonds issued by a company typically are referred to as subordinated debt, because a junior bondholder's claim for repayment of the principal of such bonds is subordinated to the claims of bondholders holding the issuer's more senior debt.
|Who Gets Paid First?|
|1. Secured (collateralized) bondholders|
|2. Unsecured bondholders|
|3. Holders of subordinated debt|
|4. Preferred stockholders|
|5. Common stockholders|
Guaranteed and Insured Bonds: Certain bonds may be referred to as guaranteed or insured. This means that a third party has agreed to make the bond's interest and principal payments, when due, if the issuer is unable to make these payments. You should keep in mind that such guarantees are only as valuable as the creditworthiness of the third-party making the guarantee or providing the insurance.
Convertibles: Convertible bonds offer holders the income of regular bonds and also an option to convert into shares of common stock of the same issuer at a pre-established price, even if the market price of the stock is higher. Convertible bond prices are influenced most by the current price—and the perceived prospects of the future price—of the underlying stock into which they are convertible. As a tradeoff for this conversion privilege, convertible bonds typically yield less.
Corporate Securities Snapshot
|Minimum Investment||Generally $1,000|
|Interest Payment||Fixed, floating/variable and zero-coupon. Interest is paid semiannually for fixed-coupon security.|
|How to Buy/Sell||Through a broker|
|Bond Interest Rate||Determined at origination, varies by bond|
|Price Information||FINRA Market Data—Bonds|
|Risk Profile||Credit and default risk: Varies significantly from bond to bond and is sometimes hard to determine.
Liquidity risk: Many corporate bonds are illiquid, making it hard to find a buyer if you need to sell your bond.
Interest rate risk: If interest rates rise, the value of a corporate bond on the secondary market will likely fall.
Event risk: Mergers, acquisitions and other tumultuous events can have a negative impact on a bond issuer's ability to pay its creditors.
|Website for More Info||FINRA Market Data—Bonds|