What Are the Features of a Corporate Bond Prospectus?

Some of the main features of a corporate bond prospectus are information on interest payments, time to maturity, the credit quality of the issuer, and call provisions. The prospectus is a great place to learn if a corporate bond is worth purchasing. Understanding all the features and risks of a corporate bond is a valuable part of making an informed decision.

KEY TAKEAWAYS

  • Some of the main features of a corporate bond prospectus are information on interest payments, time to maturity, the credit quality of the issuer, and call provisions.
  • The prospectus’s job is to provide all the essential information investors need concerning the issuer and the bond.
  • Other valuable features of a corporate bond prospectus include the general outlook for the firm, plans for earning repayment funds, and price projections.
  • The types of corporate bond prospectuses are the preliminary prospectus and the final prospectus.

How a Corporate Bond Prospectus Works

Even though it can be challenging to understand, investors must study a corporate bond's prospectus as carefully as possible. It is 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 information on what they intend to use the money for. In the U.S., a prospectus must be filed with the Securities and Exchange Commission (SEC).

Small investors should usually stick to individual corporate bonds with investment-grade credit ratings to avoid defaults and liquidity problems.

Specific Features of a Corporate Bond Prospectus

Timing and Conditions of Interest Payments

The prospectus contains information 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.

Date of Maturity

The date of maturity determines the corporate bond's life span. This states exactly how long the bond must be held until the principal is repaid. On the date of maturity, the principal and the final payment of interest are due. There are typically three ranges of maturity dates: short term, intermediate term, and long term, with the shortest being around one year in length. This is essential information for investors. For example, a bond with a maturity date four years in the future will pay back the principal in half the time of one that has an eight-year time to maturity.

Additionally, corporate bonds with a shorter time to maturity have less time for business conditions to change and increase risks. A lower time to maturity usually means less price volatility for a corporate bond. This can be explained by the term structure of interest rates.

Credit Rating

A corporate bond’s credit rating influences the interest rate paid and provides an excellent guide to the risk that a bond will default. The credit quality of the issuer is one of the most significant features to look for in the prospectus. A higher credit rating means that a corporate bond is less likely to default, but it also typically pays less interest. Small investors should usually stick to individual corporate bonds with investment-grade credit ratings to avoid defaults and liquidity problems.

Call Provisions and Protections

An issuer may offer a corporate bond with a special provision that allows them to put an early call on it. If a bond is called, the issuer repays the bond principal immediately and stops making interest payments. Such provisions provide issuers with a way to get out of making high interest payments after business or market conditions improve. For example, a firm might issue ten-year bonds with high interest rates to avoid bankruptcy during a recession. When conditions have improved, the firm might call the old bonds and issue new ones so they can refinance at lower rates.

Conversely, there are also early call protections that can be included. Call protections guarantee payments will be made for a certain length of time before calling the corporate bond. A corporate bond prospectus that contains such provisions also usually provides details about the risks of such an early call occurring.

Other Features

Other valuable features of a corporate bond prospectus include the general outlook for the firm, plans for earning repayment funds, and price projections. The issuer’s performance, the liquidity of the issue, and whether or not it is an insured bond can also be important. All of these features and risks help an investor understand how much the bond will be worth in various circumstances.

Types of Prospectuses

When looking at bonds specifically, as with stocks, there are two types of prospectuses. The types of corporate bond prospectuses are the preliminary prospectus and the final prospectus.

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, the corporate bonds can be sold on the market. A final prospectus is issued that replaces the preliminary prospectus. The final prospectus is typically the most important one for investors.

The Bottom Line

Although a corporate bond prospectus can be rather dense and difficult to read, most of the features discussed above are usually in the first few pages. Moreover, it is better to pay attention to the relevant sections of a prospectus rather than read the entire document. Remember, your skills will improve with practice.