Business, Legal & Accounting Glossary
A Corporate Bond is a bond issued by a corporation. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date. (The term “commercial paper” is sometimes used for instruments with a shorter maturity.)
Sometimes, the term “corporate bonds” is used to include all bonds except those issued by governments in their own currencies. Strictly speaking, however, it only applies to those issued by corporations. The bonds of local authorities and supranational organizations do not fit in either category.
Corporate bonds are often listed on major exchanges (bonds there are called “listed” bonds) and ECNs like MarketAxess, and the coupon (i.e. interest payment) is usually taxable. Sometimes this coupon can be zero with a high redemption value. However, despite being listed on exchanges, the vast majority of trading volume in corporate bonds in most developed markets takes place in decentralized, dealer-based, over-the-counter markets.
Some corporate bonds have an embedded call option that allows the issuer to redeem the debt before its maturity date. Other bonds, known as convertible bonds, allow investors to convert the bond into equity.
One can obtain an unfunded synthetic exposure to corporate bonds via credit default swaps.
A corporate bond is an interest-bearing or discounted debt security issued by a corporation. Corporate bonds are essentially loans by the investor to the issuing company in return for interest payments. They are fixed-income securities.
A type of bond issued by a corporation. Corporate bonds often pay higher rates than government or municipal bonds, because they tend to be riskier. The bond holder receives interest payments (yield) and the principal, usually $1000, is repaid on a fixed maturity date (bonds can mature anywhere between 1 to 30 years). Generally, changes in interest rates are reflected in bond prices. Bonds are considered to be less risky than stocks, since the company has to pay off all its debts (including bonds) before it handles its obligations to stockholders. Corporate bonds have a wide range of ratings and yields because the financial health of the issuers can vary widely. A high-quality Blue Chip company might have bonds carrying an investment-grade rating such as AA (with a low yield but a lower risk of default), while a startup company might have bonds carrying a “junk bond” rating (with a high yield but a higher risk of default). Corporate bonds are traded on major exchanges and are taxable.
The type of bond that is known as a corporate bond is the issuance of a particular type of security from a corporation or other type of company. This is a type of bond which is issued by a corporate entity in order to produce capital that can help to grow the business in some way. This is a term which is often applied to the debt instruments that carry longer-term dates of maturity, and the typical minimum level of maturity date is at least a year after such a bond’s date of issue. In some cases, shorter duration notes are issued, but these tend to be known as commercial paper.
There are occasions when the phrase corporate bond can be used in reference to any type of bond that is not issued in the currency of the nation in question by a government entity. As a general rule, however, the only technical reason to call any type of bond a corporate bond is if it is issued by a corporation. Such a categorical description does not apply to the bonds that are issued by national or more local governments and other such authorities.
The various types of corporate bonds are generally listed out on the major exchanges, and this marks them as what are known as listed types of bonds. They can also be listed on ECNs. In this type of context, the interest that is paid or the coupon payment can be taxed. However, the coupon may also be zero and simply carry a high level of value at the bond’s redemption term. Although, there are times when being listed on an exchange does not produce the maximal level of trading. In many of the highly developed markets, a great deal of such trading is carried out along markets that are over the proverbial counter, are not centralized and are based on the individual dealer.
There are also a number of corporate bonds which have call options that are embedded into them. These options let the issuer redeem such a bond before its actual maturity date. There are also types of bonds that are called convertible bonds that also let their investors turn the bonds into equity stakes in the company itself.
The spreads on corporate credit can also be received if one is willing to trade on the level of default risk present. This type of instrument is known as a credit default swap or CDS, and it provides a level of synthetic exposure that is not funded and is based on what is known as reference entities. Naturally, since there is often a very volatile basis from which a CDS is derived, the level of spread on a corporate bond can be tremendously different from the spread that is present in a CDS.
Corporate bonds are classified by their bond rating and their maturity. Bond ratings are assigned by bond rating agencies including firms such as Standard and Poor’s, Moody’s, and Fitch. Several rating systems are used, but the most common one ranges from AAA for the safest to C- for the least secure. Investment-grade bonds are rated from AAA to BBB-. BB+ and below bonds are considered junk bonds.
Bond maturity is the date on which a bond expires. A bond is a contract to pay interest at a specified rate, i.e. the coupon, and on specified dates until the maturity date. At maturity, the issuer agrees to refund the face value of the bond.
Bonds are classified by maturity as short, usually under about two years, and long, usually over about 15 years. In between are intermediate bonds. Prices of short bonds respond quickly to changes in interest rates and especially actions by the Federal Reserve Board. Long bonds tend to respond more slowly. However, the yield curve of US Treasury bonds is the reference point.
Changes in interest rates cause the market value of bonds to change. Rises in interest rates cause bond prices to fall so the bond, which pays a fixed amount of interest, pays market interest rates to the buyer. Conversely, falling interest rates can cause the market value of a bond to increase, making possible a sale for capital gains.
Bond yield changes with market conditions and can be different from the coupon yield when the market price of the bond is other than the face value.
Zero-coupon bonds are bonds paying no interest. They are sold at a deep discount and then pay face value at maturity.
Bonds are bought and sold by bond traders or by the bond desk of your broker. Although some bonds are listed on major exchanges, most are traded over the counter. Most individual investors find it necessary to hold bonds to maturity as the resale market is limited. Bonds can be sold but usually at the price offered by the bond desk of your broker. Bid-ask spreads are said to be wide.
Asset-backed securities or trust preferred issues are a new class of bonds. They are listed and traded on major stock exchanges as preferred stocks. Each issue is backed by a single corporate bond. Hence, these are in effect corporate bonds traded on major stock exchanges and available at discount broker commissions.
Many bonds are callable. The issuer may call the bond at a specified price on or after a specified date. The details are listed in the prospectus for the issue. QuantumOnline [1] does an excellent job of summarizing call provisions. They also provide links to the original prospectus for the issue. (But the bond ratings shown may not be up to date.)
Those considering purchase of a bond should research call provisions. Bond yields are often supported by the call price. Paying a premium over the call price can result in having the bond called out from under you at a loss. Hence, bonds near or after their call date often have their market value held down by the call price. That can cause them to show up in bond listings as remarkably high-yielding bonds. Be especially careful of bonds paying above-market yields.
As a general rule, the higher up the position of one’s ownership within the capital structure is, the stronger a claim one may make on the assets the company possesses if the company is forced to default on its various obligations.
By comparison to the government type of bonds, the bonds that corporations issue are typically the carriers of higher default risk. Such a risk level can depend on the particulars within the company that issues any given bond, and as well the market conditions and government actions that can be compared to the company as well as how the company is rated on the basis of its general credit. The holders of corporate bonds are typically compensated for the additional risk that they take on through the receipt of a higher level of interest rate yield than that which a government bond would pay. This difference between the yield level of a government bond and that of a corporate bond comes because there is a higher risk of a corporation defaulting than a government defaulting. There is also a greater likelihood of loss in the event of a default in such a case, and there may even be less liquidity in a corporate bond’s case.
Compared to government bonds, corporate bonds generally have a higher risk of default. This risk depends, of course, upon the particular corporation issuing the bond, the current market conditions and governments to which the bond issuer is being compared, and the rating of the company. Corporate bond holders are compensated for this risk by receiving a higher yield than government bonds.
Consequently, this default risk can be quantified using spread analysis, which seeks to determine the difference in yield between a given corporate bond and a risk-free treasury bond of the same maturity. Common statistics used include Z-spread and option-adjusted spread (OAS).
convertible bond
guaranteed bond
accrued interest
after-tax basis
bond quote
collateral trust certificate
face value
municipal bond
par
par value
Corporations secure long-term financing primarily through the issuance of stocks and bonds. Stock represents permanent capital whereas bonds are long-term debt. A recurring question relates to the fraction of a corporation’s financing that should be equity or debt. Modigliani-Miller theory states that the relative allocation between the two is irrelevant to existing shareholders’ interests. However, that theory is based on strong simplifying assumptions, including an assumption of no taxes. While tax law varies from one jurisdiction to another, the interest a corporation pays on its bonds is generally deductible as a business expense. Dividends paid to stockholders are not. For this and other reasons, the question of how corporations should allocate their financing between debt and equity recurs in practice.
Corporate bonds typically have terms between 12 and 30 years, but there have been issues with terms of 50 and even 100 years. Shorter-term bonds are also issued, but these may be called notes. While structures vary, corporate bonds are typically issued at a price close to their par value and pay a fixed semi-annual coupon. Their nominal yield is specified as a semi-annual interest rate. For example, if a bond has a par value of USD 100 and a nominal yield of 7.0%, it pays a coupon of USD 3.5 every six months until maturity, at which time a final coupon and the par value are paid to investors.
Corporations may issue bonds as private placements, or they may engage an investment bank to conduct a public offering. In the latter case, the bank may act as principal, purchasing bonds from the corporation either with a firm commitment or standby agreement. It may also act as agent, selling bonds to the public under a best efforts commitment. Once issued, some publicly-offered bonds trade on exchanges such as the New York Stock Exchange, but most trade over the counter (OTC). If a bond trades OTC, the bank that handled the public offering usually acts as a market maker.
Bond indentures can include a variety of provisions. A call provision grants the issuer an option to redeem bonds early. Some bonds have a sinking fund provision that requires the issuer to set aside funds to retire a specified amount of bonds each year.
Corporate bonds entail credit risk, and indentures include provisions to mitigate this or clarify the rights of bondholders in the event of a default. Bonds may have some form of credit enhancement such as a third-party guarantee. Bonds can be secured or unsecured. Secured bonds are collateralized by specific assets of the corporation. Unsecured bonds, called debentures, are general obligations of the issuer. They are not secured by any specific collateral, so investors’ claims are backed only by the corporation’s general assets. A corporation may issue senior and subordinated debentures. In a liquidation, the claims of senior debentures must be satisfied in full before anything can be paid to holders of subordinate debentures.
In a reorganization, a troubled company may offer income bonds to investors in exchange for bonds they already hold. These are unsecured bonds that require the issuer to make scheduled coupon payments only if it has the income to do so. Failure to pay coupons cannot drive the issuer into bankruptcy. Missed coupons may accumulate or they may not. If they do accumulate, they may do so with interest. Income bond indentures vary considerably, but they are likely to prohibit the paying of dividends to stockholders unless obligations to the bondholders are met. In many respects, income bonds resemble preferred stock.
There are various forms of secured bonds. Mortgage bonds are collateralized by assets such as power plants or factories. Should the corporation be liquidated, the bondholders have a direct claim on those assets. A mortgage bond can be open-ended or closed-ended. An open-ended mortgage bond allows the corporation to issue more bonds backed by the same collateral and of equal seniority. This means the bondholders’ claim on the collateral can be diluted. With a closed-end mortgage bond, the corporation may issue more bonds backed by the same collateral, but bonds are divided into classes according to the order in which they were issued. The classes are called the first mortgage, second mortgage, etc. Earlier classes have higher seniority than later classes. In a liquidation, claims are satisfied in the order of seniority. First, mortgage claims must be paid in full before subordinate claims can be paid.
The protection that collateral affords holders of mortgage bonds is limited. Bankruptcy proceedings can be lengthy, expensive and unpredictable processes. If they result in a reorganization instead of a liquidation, holders of mortgage bonds may lose their seniority to new investors. In such a case, the new investors receive what are called prior lien bonds. These are treated as first mortgages, and previously issued bonds have subordinate claims. If, on the other hand, bankruptcy results in liquidation, the relative seniority of bondholders is generally honored, but collateral may have insufficient liquidation value to satisfy all claims. Due to shortcomings such as these, mortgage bonds are falling out of use. Most are issued by utilities.
More popular are equipment trust certificates. These are a form of structured finance backed by collateral such as railroad cars, airliners or trucks. A corporation might contribute 20% of the purchase price of the assets with the balance coming from purchasers of the certificates. The assets are held by a trust, which leases them to the corporation. Lease payments to the trust are passed, minus expenses, to investors as interest on the certificates. Both the nature of the collateral and the fact that it is held in a trust, make it easy to liquidate in the event of default. Certificates generally have staggered maturities or a sinking fund provision that allows the debt to be retired more rapidly than the collateral is depreciated. Deals are generally structured to maximize depreciation and/or leasing tax benefits for the issuing corporation. Once all the debt is retired, the collateral is transferred to the corporation.
To help you cite our definitions in your bibliography, here is the proper citation layout for the three major formatting styles, with all of the relevant information filled in.
Definitions for Corporate Bond are sourced/syndicated and enhanced from:
This glossary post was last updated: 29th December, 2021 | 0 Views.