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About Corporate Bonds, Risks and Benefits
By Milos Pesic
In a life filled with risk, it pays to play it safe sometimes as the smart ones have learned with corporate bonds. What are corporate bonds? They are the money raised by corporations over and above the sales, services, loans from banks and stocks. Unfortunately, not too many investors have taken the time and the effort to understand this instrument.
A bond is a loan to a company and like loans, there is a date when the loan has to be paid back and a rate of interest that has to be paid on that loan in the meantime. Bonds are usually with companies for 10 years after which they reach their maturity date.
While they are relatively safe, bonds too have certain risk factors which we are going to look at. These can be classified under the terms Credit Risk, Interest Risk and Maturity Risk.
There are defaulters where bonds are concerned too and even after not paying their debts, companies just can go on, carrying on with their business. So you have to make up your mind whether you want to sue or to settle. There are, happily, Bond Credit Ratings agencies which rate the credit risk of a company. Poor’s and Moody’s and Standard are two such agencies.
There is a coupon rate or an interest rate attached to each bond – however, these may change depending on market factors. Interest rates can change as well and you might get lucky and find that the interest on your bond has gone up. When you want to sell a bond, you will find that it fetches a better price on maturity than before maturity or if it has just been bought.
There are some bonds that are allowed redemption before they mature. These are called being ‘callable’. So they can pay for the bond you hold with cash or issue new bonds against it or maybe even a bank loan. This means that if you have been used to getting a high rate of interest, this might suddenly stop if the company tends to call up the bond.
Let’s now look at the advantages. If you are cautious and invest in high yield bonds that are healthy and not junk bonds, you can stand to gain a lot. You also have convertible bonds where you can buy bonds that convert into stock directly from the company rather than from the market. This means you can take advantage of the company’s price appreciation while enjoying the safety factor of a bond. The price of the bond usually does not fall below a decent price return.
Like any other financial investment, you need to make informed choices and for this, you need to be well up on what is happening in the market. The great thing about bonds is that the benefits as well as the risks are transparent and easily gauged.