Insight to the Prospectus of Corporate Bonds
A prospectus is a legal document that details an investment intended for a public offering. The prospectus includes all the details and facts investors require to make a well-informed decision about the offered security. In the U.S., a prospectus must be filed with the SEC.
Because of the number of significant details concerning a security or bond contained in a prospectus, this is a great place for an investor to start learning about whether or not a corporate bond is worth purchasing – no matter who they are purchasing the bond from. As with any purchase, understanding all the features and risks a corporate bond comes with is a valuable part of making an informed decision.
When looking at bonds specifically, as with stocks, there are two specific types of prospectuses:
- Preliminary Prospectus: As the name suggests, this prospectus is the first or initial prospectus used by an issuer. It typically contains most of the details of a bond offering by the corporation.
- Final Prospectus: Once a deal on a security offering is finalized and the corporate bonds can be sold on the market, a final prospectus is issued that replaces the preliminary prospectus. So the final prospectus is one of most importance to investors.
The Significance of the Prospectus
Even though they can be difficult to understand, it’s critical that investors study a corporate bond’s prospectus as closely as possible because it’s the closest thing to a guide on how the bond in question works. The prospectus’s job is to provide all the essential information investors need concerning the issuer and the bond. This includes things like what they intend to use the money for. According to ASIC (2010) and Sessoms (2014) some of the most important areas of a prospectus for investors to pay attention to are as follows:
- Features, Risks and Indicators Risks of the Corporate Bond: All kinds of features like a corporate bond's outlook (which helps determine future favorability in the market), plans for how to earn repayment funds, the corporate bond’s credit rating info, price projections, the issuer’s performance and liquidity and whether or not it is an insured bond. All of these features and risks are important in helping an investor understanding how much the bond will be worth in various positive or negative circumstances that may arise over the lifetime of the bond.
- Timing and Conditions of Interest Payments: A prospectus is a great place to learn about a corporate bond’s predetermined coupon or interest rate. Because yield is determined by the corporate bond’s face value and its interest rate, this is essential information. There should also be details of payment schedules, a common feature of corporate bonds.
- Corporate Bonds Date of Maturity: The corporate bond’s lifespan is determined by its date of maturity. This states exactly how long the bond must be held until the principal will be repaid. On this date, not only the principal, but all final payments of interest due must be made. Typically, there are three ranges of maturity dates: short-term, medium-term, and long-term, with the shortest being around one year in length. This is key for investors because, for instance, a bond with a maturity date of four years will pay back the principal in half the time of one that has an eight-year maturity date. Additionally, the shorter the bond, the less time there is for adverse conditions to negatively impact its value or interest rate. This is the reason why many investors prefer short-dated corporate bonds over a longer term to maturity. Usually the lesser the time to maturity, the lesser the volatility of the corporate bonds’ prices. This can be explained by the so-called term structure of interest rates.
- Early Call Provisions and/or Protections: Sometimes an issuer offers a corporate bond with a special provision that allows them to put an “early call” on it. In this occurrence, the maturity date of the corporate bond will become invalid, and the bond principal will be paid back. Such provisions provide issuers a way to get out from under the obligation of making scheduled interest payments but leave investors potentially in a jam if depending on those interest payments for capital. Conversely, there are also early call protections that can be included to protect investors by guaranteeing payments to be made for at least a certain length of time before calling the corporate bond. Typically, a corporate bond’s prospectus that includes such provisions also includes details of the risks of such an early call occurring.
The Bottom Line
Though a prospectus of a corporate bond can be rather dense and difficult to read through, most of the information above-mentioned should be located within the first few pages. Moreover, it is clearly about getting used to paying attention to the relevant sections of a prospectus and not reading the entire document from front to back. Again, skill comes with practice.