Tutorial: Corporate Bonds

What are corporate bonds?

Corporate bonds are debentures issued by a company. The array of companies is as vast as their sectors, with a certain focus on automobile, construction, financial service providers, energy, telecommunication, tobacco, and food. Corporate bonds are used for funding debt capital requirements.

How do corporate bonds work?

Corporate bonds are issued as fixed- or floating-rate securities. The coupon is usually paid once a year, and at the end of maturity the bond is redeemed at nominal value. The maturities are usually within a range of five to twenty years. One criterion of evaluation for a bond is the rating it gets from independent rating agencies. The lower the rating, the riskier the investment – and the higher the interest rate.

Your benefits

When subscribing to a corporate bonds, you decide in favour of the variety and know-how of the company. You can follow a long-term ("buy-to-hold") strategy and do not have to monitor the daily fluctuations on the equity markets.

Your advantages

You benefit from attractive interest rates and periodical interest payments.
You can invest in well-known companies.

Details you should be aware of

The downgrading of the rating of a company during the term of the bond may lead to price losses.
Between issue date and maturity, price fluctuations are possible, which means that the sale of the bond prior to maturity may result in a loss.
The 100% capital redemption only applies to the end of maturity.

How do corporate bonds react to…

… rising interest rates?
Corporate bonds with fixed interest rate fall when interest rates are rising. If you sell these bonds prior to maturity, you may record a loss.
Corporate bonds with floating interest rate, on the other hand, benefit from rising interest rates. Given that these bonds ("floaters") have their interest rate periodically adjusted to a referential rate such as the Euribor, an increase in the level of interest rates also means a rising interest rate for the bonds. The price of the bond tends to oscillate around face value.

… stable interest rates?
In the case of stable interest rates, neither the price nor the coupon of corporate bonds changes.

… falling interest rates?
Corporate bonds with fixed interest rate increase when interest rates are falling. If you sell these bonds prior to maturity, you may record a profit.
Falling interest rates, on the other hand, have a negative impact on corporate bonds with floating interest rate. Given that these bonds ("floaters") have their interest rate periodically adjusted to a referential rate such as the Euribor, a decrease in the level of interest rates also means a falling interest rate for the bonds. The price of the bond tends to oscillate around face value.

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