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.
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.
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).
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This glossary post was last updated: 1st May, 2020 | 0 Views.