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What are corporate bonds?

Just as governments issue bonds to finance public spending, so companies issue bonds to raise money to invest in their business.

For companies, corporate bonds provide an alternative to raising money by issuing shares. For private investors, corporate bonds offer the opportunity to buy a fixed income in exchange for an investment of capital.

All types of corporate bonds share common traits that you need to understand before you consider an investment.

Corporate bonds have a nominal value, an interest rate, and a stated redemption date:

  • The nominal value (or principal) is the initial price paid for the bonds
  • The interest rate (or coupon) states the income you’ll be regularly paid for owning the bond (it’s usually fixed for the life of the bond)
  • The redemption date is the specific date when the company will repay you the nominal value of your bonds

Corporate bonds are traded on the stock market, just like shares. This means the price of a corporate bond fluctuates between the issue date and the redemption date.

The interest rate paid by a bond at a particular price is called the current yield. It’s also known as the income, earnings, flat, running or interest yield, and is expressed as a percentage.

When the price of a bond rises, the current yield falls, because you must pay more for the same amount of income from the bond.

When the price of a bond falls, the current yield rises, since you pay less money to buy the same amount of income from the bond.

Note that commentators usually talk about bond yields rising and falling, and the consequences for prices, rather than the other way around, since it’s the yield and its relation to the wider interest rate environment that drives bond valuations. The reality is that bonds are being bought and sold at changing prices, so changing the yield. But it’s the yield that drives the price changes.

If you hold a bond to maturity, you’ll get the stated nominal value returned to you. This nominal value may be higher or lower than the price you pay in the market for a bond, depending on whether you buy the bond at a discount or a premium.

The redemption yield indicates the total return due from holding a bond to maturity; it incorporates capital gains or losses that will be due at redemption, as well as the income due from the bond coupon.

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