Corporate Bonds
Investors buy corporate bonds for various reasons, which may include: attractive and predictable returns, dependable income, cash flows, flexibility, and diversification. Corporate bonds are debt obligations issued by U.S. and foreign companies to raise capital for business growth and general corporate purposes. Many are unsecured promises to repay the principal at a predetermined future date, although some bonds may be secured by company assets used as collateral. The issuing company also agrees to pay interest to compensate investors for lending their money. Unlike stocks, which represent ownership in a company, bonds are obligations of the corporation to pay back the borrowed funds and investors have no voting or ownership rights. Bondholders have priority in debt hierarchy over stockholders and are paid interest and principal prior to any dividend distributions.
FEATURES OF CORPORATE BONDS
Predictable Income Most corporate bonds offer fixed interest payments for the life of the bond, which typically are paid semi-annually, but may be paid quarterly, monthly or at maturity. Interest rate and payment frequency are set at the time of issuance, so investors always know when and how much to expect. This is especially beneficial for retirees and other investors that rely on fixed income ad have fixed expenditures.
Competitive Returns Corporate bonds have varying credit ratings that range from investment grade to non-investment grade (high yield or junk). Corporate bonds are considered a riskier credit versus government-backed Treasury bonds. Therefore, they generally offer higher yields versus Treasuries. Yields vary among corporate bond issuers based on different risk factors, including an issuer’s creditworthiness, coupon, maturity, and its industry. Economic factors and changing market conditions may have a greater effect on some industries. Corporations and industries perceived to have more risk will have to offer higher yields. Corporate bonds present investment opportunities for many levels of risk tolerance. Therefore, investors should carefully examine each bond’s characteristics to determine if a higher yield is worth extra risk. Investors willing to accept higher risk may benefit from potentially higher returns. Longer maturity bonds may offer higher rates, as their market prices tend to be more sensitive to changes in interest rates. Investment grade corporate bonds, although there are no guarantees, have historically shown low default percentages.
Credit Ratings Corporate bonds are rated by independent rating agencies, such as Moody’s Investors Service, Standard and Poor’s Financial Services, LLC and/or Fitch Ratings Ltd. Ratings are appraisals of the issuer’s ability to pay interest and principal and are not recommendations to buy, sell or hold. Credit ratings are subject to reviews, changes or withdrawal at any time.
Bonds carrying a credit rating of Baa3/BBB- or higher are considered investment grade. Most offerings are unsecured debt and backed only by the issuer’s promise to pay. Therefore, a bond’s value may decrease if the issuer’s credit rating deteriorates or conversely increase if an issuer's credit rating improves. Bonds with a credit rating below Baa3/BBB- are called “junk bonds” and should only be purchased by investors with a high tolerance for risk as there may be a possibility of significant price volatility and a potential loss of the entire investment. More information about credit ratings is available at moodys.com, standardandpoors.com and fitchratings.com.
Coupon Structures Include:
Fixed coupon rate is set at the time of issuance and does not change until the bond has matured. The interest payments are predictable and, usually, paid semi-annually or monthly.
Zero coupon rate bonds do not pay any interest during their lifetimes and are issued at a deep discount from par value. The interest earned is built into the discounted price and is taxed annually although not received by the investor until maturity.
Floating coupon rate is tied to a reference benchmark, such as short-term Treasury bills, LIBOR/SOFR or CPI indices, and changes as the corresponding indices resets. The interest rate is quoted as a certain number of basis points over the index – and is known as its margin. For example: SOFR + 250 basis points indicates that the reference rate is SOFR and the margin is 250. The margin is determined at the time of issuance and remains fixed until maturity. As the index adjusts, so does the coupon and thus the interest payments.
Step coupon rate changes at predetermined intervals and usually increases (steps up) in equal increments. The step rate schedule is established at the time of issuance. These securities are generally issued with a call feature. The initial interest rate is paid until the first call date and, if not called, steps to the next level. Step-up bonds may offer lower initial interest rates than comparable fixed rate securities; however, if not called, they will keep stepping up and may result in a higher total return. This can be a defensive strategy if investors anticipate an increase in market interest rates.
Survivor’s Option Although not a common feature, some corporate bonds offer an estate protection feature, which allows an estate, upon evidence of death of the bondholder, to redeem bonds from the issuer at par plus any accrued interest. This feature may be subject to minimum holding periods, individual limits, issuer limits and other rules that vary by issuer. Terms and conditions are fully described in the prospectus, offering circular or disclosure document. You should not rely on this feature for immediate liquidity.
Liquidity Although not obligated to do so, many broker/dealers participate in the secondary market for corporate bonds. Investors who need access to cash may sell their bonds prior to maturity, at current market prices. In the secondary market, prices are subject to market interest rates, issue and position size, credit rating, and other factors. Some bonds trade more often than others and may be easier to sell. The proceeds from a sale may be more or less than the original investment. However, if bonds are held until the final maturity date and barring a default, the investor will receive the face value of the corporate bond.
To improve market transparency, the Financial Industry Regulatory Authority (FINRA) created TRACE – Trade Reporting and Compliance Engine. Investors can access historical data on market transactions for publicly traded securities, including corporate bonds, at https://www.sec.gov/search-filings.
Priority of Claim Should the bond issuer become insolvent, the company’s assets may be liquidated to compensate the creditors, including the bondholders. Corporate bonds provide investors with a higher priority of claim on the assets of the issuer than the holders of preferred securities or common stock.
| PRIORITY OF CLAIMS Listed from highest to lowest |
|---|
| Senior Secured Debt Holders |
| Senior Unsecured Debt Holders |
| Subordinated Debt Holders |
| Preferred Stockholders |
| Common Stockholders |
Taxation Interest income from corporate bonds is generally subject to federal, state and/or local taxes. Investors who decide to sell bonds before the final maturity date may incur capital or ordinary gains or losses and are advised to consult a tax advisor to ensure proper tax reporting.
Risk Considerations:
There are special risks associated with investing with bonds such as interest rate risk, market risk, call risk, prepayment risk, credit risk, reinvestment risk, and unique tax consequences. To learn more about these risks and the suitability of these bonds for you, please contact our office.
- Bonds are subject to risk factors including:
- Default Risk - the risk that the issuer of the bond might default on its obligation
- Rating Downgrade - the risk that a rating agency lowers a debt issuer's bond rating
- Reinvestment Risk - the risk that a bond might mature when interest rates fall, forcing the investor to accept lower rates of interest (this includes the risk of early redemption when a company calls its bonds before maturity)
- Interest Rate Risk - this is the risk that bond prices tend to fall as interest rates rise.
Investing involves risk and you may incur a profit or a loss. The value of fixed income securities fluctuates and investors may receive more or less than their original investments if sold prior to maturity. Bonds are subject to price change and availability. Investments in debt securities involve a variety of risks, including credit risk, interest rate risk, and liquidity risk. Investments in debt securities rated below investment grade (commonly referred to as “junk bonds”) may be subject to greater levels of credit and liquidity risk than investments in investment grade securities. Investors who own fixed income securities should be aware of the relationship between interest rates and the price of those securities. As a general rule, the price of a bond moves inversely to changes in interest rates. Diversification does not ensure a profit or protect against a loss.
Bonds may receive credit ratings from a number of agencies however, Standard & Poor's ratings range from AAA to D, with any bond with a rating BBB or higher considered to be investment grade. Securities rated below investment grade generally provide a higher yield but carry a higher risk of default which could result on a loss of the principal investment. Because high-yield bonds have greater credit and default risk they may not be appropriate for all investors. While bonds rated investment grade have lower credit and default risk, there is no guarantee securing the principal investment. Past performance is no assurance of future results.
The information contained herein has been prepared from sources believed reliable but is not guaranteed by Raymond James & Associates, Inc. (RJA) and is not a complete summary or statement of all available data, nor is it to be construed as an offer to buy or sell any securities referred to herein. Additional information is available upon request.
Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value.
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