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The Risks And Benefits Of Corporate Bonds |
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Submitted by Trent Orosco
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Rarely will you find an investment where you gain a substantial reward without an equally substantial amount of risk. Let's face it - the odds are stacked against you. Not only are there other huge banks and multinational corporations you have to compete against that have more capital than you will ever have, but there are millions of other investors trying to test their luck in the same market. Your choice of where to invest your money is therefore highly important. This is where corporate bonds come into play.
1. Corporate Bonds
Many times, corporations have great sales and service records but just don't have the funds needed for a particular initiative. A corporate bond is high yield as essentially you are lending the company your money.
2. Credit Risk
Of course, you have to consider that many companies seek bonds because they are in financial trouble and need a quick cash injection to keep themselves afloat. It will be up to you to differentiate that companies are looking for a handout and that legitimately have a quality operation and simply need funds to expand and grow their business.
3. Corporate Bond Ratings
Credit risk on bonds is actually rated in an easily understandable fashion. Triple A bonds are very low risk, and similarly low yield. BB is considered junk - very risky but potentially insane payouts, all the way to D (avoid these at all costs).
4. Interest Rates
If you are going to be acquiring a bond, of the things you should look for, the interest rate is high on the priority list. Getting a bond with even a 1% better rate of interest can result in hundreds of additional dollars in your pocket each year. Since general interest rates can change, a bond purchased today offering 5% is worth less if interest rates in general rise to 8% a year later.
5. Life To Maturity
Many corporate bonds come with the option to be callable. This means that they can be redeemed prior to the date of maturity. Companies do this when interest rates fall, and they wish not to continue making high interest payments to bondholders. In essence, this is a form of corporate re-financing similar to that done by homeowners with their home equity. That callable feature represents the risk to an investor that, though initially receiving high interest payments, they may not be able to enjoy that same rate for the life of the bond. As a consequence, those bonds are often less expensive and have lower interest rates.
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