Corporate Bonds

When you invest in corporate bonds, you are lending money to a company and in return you receive a specific interest rate for a specific period of time. When the time period is over, or the bond matures, you receive your original investment amount back. Corporate bonds have maturity dates ranging anywhere from ten to thirty years. In addition, these types of bonds are securities and you can purchase them through a broker.

Interest rate factors. The interest rate you receive on corporate bonds depends on several factors including the length of the maturity. Generally, longer-term bonds pay higher interest rates as an incentive for investors to lock in their funds for such a long period of time.

The interest rate you receive on corporate bonds depends even more so on the strength of a corporation's finances. The stronger that a corporation's credit record is, the less interest you'll receive on bonds it issues. Why? It's the risk vs. safety feature. The safest bonds, those issued by financially strong corporations, will attract investors for the safety of their investment. Corporations with lower credit ratings must pay higher interest rates for their bonds in order to encourage investors to take more of a risk.

While you can do background research on companies you're interested in, you should also use the credit ratings issued by firms such as Standard and Poor's and Moody's Investors Service, which assign letter grades to the credit history of corporations. The letter grades work here just as they did in school and range from a high of AAA all the way down to C.

Sometimes the interest rate paid for corporate bonds is also affected by whether the bond is backed by specific assets of the corporation rather than the corporation in general. Bonds backed by specific assets are generally safer because you can file a specific claim if there's a payment problem. As a result, the interest paid on corporate bonds backed by specific assets is usually lower than the interest paid on a company's general bonds.

Warning Many corporate bonds can be redeemed (it is known as a callable bond in the financial industry) before their maturity date. Corporations want this feature for their bonds because if an investor locks in a high interest rate for a 20-year term for example, then the corporation will want to get out of this deal if the interest rates drop. Can a corporation do this? They can if this is one of the features of the bond. If a corporation exercises this feature, your 20-year bond could be called and redeemed for face value years before the 20-year period is over. You then have the option of buying the corporation's bond again, but at a lower interest rate. You'll want to make sure you find out if corporate bonds you're contemplating contain this feature, and if they do, consider this a risk you should include in your assessment of this investment.

Some corporate bonds have a feature that allows them to be exchanged for a specific number of shares of the corporation's stock. The good thing about this type of corporate bond is that the value of your bond goes up if the corporation's stock is on the rise. The downside of this type of bond is that it usually pays interest at a lower rate than a comparable corporate bond that isn't convertible.

A good investment for most. If buying bonds in a secure corporation sounds like a good investment for most people, that's because it is. You can pick your level of risk, the corresponding interest rate, and the duration of the holding period based on your age and stage in life, your investment goals and your own personal risk tolerance. In general, corporate bonds pay higher interest rates than treasuries that mature in the same time period. As safe an investment that the best rated corporate bond may be, a comparable treasury will be safer still with the U.S. government as its backer. Therefore, an investor has to sacrifice a higher interest rate for less risk if they choose treasuries over corporate bonds.

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