Investments: A General Overview
Corporate Bonds
A discussion of
debentures is not complete
without discussing corporate
bonds. Corporate bonds
provide the more conservative
investor a worthwhile compromise
between the higher risk equity
securities and the various
conservative government
debentures.
There are two aspects to corporate bonds that are important for investors. These two aspects are RISK and TERM OF MATURITY.
Risk and Return
Corporate
bonds provide the safety of most
traditional debentures while at
the same time compensating you
for the extra risk incurred for
investing in a private
corporation. Of
course the actual risk of a
corporate bond depends greatly
on the credit-worthiness and
stability of the underlying
corporation issuing the bond.
You don’t have
to depend on your own research
or that of your broker in
evaluating most corporate bonds.
There are two well-known
companies that regularly issue
corporate bond ratings.
These companies are Moody’s and
Standard & Poor’s. These
companies have gained enough
clout (Moody’s more so in
bond’s) that the rating they
give the creditworthiness of a
corporation greatly affects its
finances in the present term and
long into the future.
Obviously the
riskier the company is
considered to be the greater the
compensation to the investor in
terms of return. It pays
to actually think about why a
company would be rated risky by
either Moody’s or S&P (Standard
& Poor’s). For
example, if a company derives a
great percent of its overall profit
from one particular product,
which might be affected by a
lawsuit, then it behooves you to
find out more about the
particulars of this situation.
These are the type of situations
that can be capitalized on
because most people will simply
follow the consensus without
actually researching the
particulars. Of course
this same rationale applies to
other investments as well.
The basic concept important to investing in corporate bonds is that return increases directly proportional to perceived risk. Notice, the key is PERCEIVED risk. Information is the most important asset in the world of investments and those with the quickest and most accurate information usually profit the most.
Term of Maturity and Return
The term of corporate securities vary in the same way that other debentures. Most terms range from less than one year up to a maximum of thirty years. The rate of return increases directly proportional to the length of term. Therefore, the maximum return will be found in securities with longer maturities.
Other Considerations for Corporate Bonds
Call Features – Some corporate bonds will contain a call feature, which allows the corporation to retire or redeem the bond partially or in full within a certain time period. This is something that obviously affects the overall return of the bond and should be considered in the analysis. Any such features will be described in the indenture which is the legal document outlining the rights and restrictions of the lender and lendee.
Secured / Unsecured – Bonds can either be secured or unsecured. A secured bond is a bond that is attached to an asset of the corporation. Therefore in the event of a bankruptcy of default the asset could be liquidated to pay off the loan.
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