What Is It?
Similar to a mortgage with a bank, bonds are an issue by a borrower to a lender. When you buy a corporate bond, you are loaning your money to a corporation for a predetermined period of time (known as the maturity). In most cases, the bond's par value is $1,000. This is the face value of the bond and the amount the lender will be repaid once the bond matures.
Of course, you're not going to loan your money for free. The borrower must also pay you a premium, known as a "coupon", at a predetermined interest rate in exchange for using your money. These interest payments are usually made every six months until maturity is reached.
There are three important factors you need to consider before buying a bond. The first is the person issuing the bond. The second is the interest (or coupon) you will receive. The third is the maturity date, the day when the borrower must pay back the principal to the lender.
Objectives and Risks
Corporate bonds offer a slightly higher yield because they carry a higher default risk than government bonds. Corporate bonds are not the greatest for capital appreciation, but they do offer an excellent source of income, especially for retirees. Corporate bonds are also highly useful for tax-deferred retirement savings accounts, which allow you to avoid taxes on the semiannual interest payments.
The risks associated with corporate bonds depend entirely on the issuing company. Purchasing bonds from well-established and profitable companies is much less risky than purchasing bonds from firms in financial trouble. Bonds from extremely unstable companies are called junk bonds and are very risky because they have a high risk of default.
How to Buy or Sell It
Corporate bonds can be bought through a full service or discount broker, a commercial bank or other financial intermediaries. The best time to buy a corporate bond is when interest rates are relatively high. (To learn more, see the Bond Basics Tutorial.)
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