The ins and out of investing in corporate bonds
Bonds aren’t (quite) forever. Though not quite as sexy as the super spy, James’ older corporate brother is a favourite for those a little less keen on life-threatening risk.
Corporate bonds can be a good way to diversify your investment portfolio, thanks to their (normally) negative correlation with stocks – but bonds can be confusing. We’ll cut through the jargon in this guide – you’ll have a license to kill in no time. 🥷🏼
What are bonds?
Bonds are a form of debt: money owed to someone. They are issued by governments (check out our learning guide on Government Bonds for more on that) or companies, and when you buy one, you are essentially loaning money to that institution. 🏢
How do they work?
A bond has a maturity date and a “coupon”: you might buy a 10-year bond with a 5% coupon with a par value of £100. That means that you’re giving the company £100 for ten years. In exchange, the company will pay you 5% interest (£5) each year until maturity, when it’ll also give you back the £100 par value.
What’s in it for the companies?
Companies issue bonds to raise money for new projects (or to keep existing, loss-making projects going). There are other ways for companies to get this cash, but none are ideal: issuing new stock involves the company’s owners giving up some of their ownership stake; and getting a bank loan for huge amounts of capital isn’t always easy (and if it is, it might be costly).
Bond issuance is a way for companies to borrow large sums 💸 reasonably easily and cheaply. The scale can be massive: Saudi Aramco made a $12 billion debut international bond sale in April 2019 to help fund its acquisition of a majority stake in local petrochemicals giant Sabic.
And for investors?
Bonds are generally a lower-risk ⛱️ investment than stocks. Fixed income and return of your capital at the end of the bond’s term mean bonds can offer the stability you can’t get from shares. But the company could go bankrupt or default on some or all of its obligations, meaning you might not be repaid.
Though even in those circumstances, bondholders get first dibs on any cash from a sale of the company – debt backed by assets gets repaid first, then “unsecured” debt. Shareholders split whatever value is left but in the case of bankruptcy, this is almost always zilch.
You’re not stuck with a bond until maturity. As with most financial products, you can trade them in the market. There is a lot to learn about that, so read on for our next session.
Keep in mind that when you invest, your capital is at risk and this learning guide is for information purposes only and is not intended as investment advice.