Corporate bonds explained

What is a corporate bond?

A bond is a loan made to a company for a fixed period by an investor, for which they receive a defined return.

Investors usually receive annual payments for their cash – usually expressed as a percentage – as well receiving the principal sum back at the end of the term.

Investment grade corporate bonds are usually issued by established companies which are deemed less likely to default on their obligations. Conversely high yield bonds (sometimes called junk bonds) carry a higher risk of capital loss, but have the potential for higher income.

In terms of duration, bonds are typically broken into three categories: short-dated, medium-dated, or long-dated.

Known as a fixed interest security, bonds typically have at least one year’s life span, with any instrument with a shorter term known as commercial paper.

Companies issue bonds in order to raise capital in the same way an individual might need to borrow money.

A bond’s main features are usually presented in its title, so a Tesco ten year bond paying 5.5% would be called: Tesco 5.5% 06/11/2019.

How are they priced?

Bonds are usually priced in percentage terms to their issue price, or ‘par value’. So if a bond is trading at par value, it will be priced at 100, while if it is trading at a price of 80 it means it has fallen in value and is currently at a discount.

Conversely, if it is trading over 100 it has gained value.

Therefore investors who buy at par are likely to see their bond either decline or rise in price over time, especially for the longer-dated bonds, and they have the potential to make capital gains on the bond if they sell it at a premium before its matures.