A discussion of debentures is not complete without discussing corporate bonds. Corporate bonds provide the more conservative investor a worthwhile compromise between the higher risk equity securities and the various conservative government debentures.
There are two aspects to corporate bonds that are important for investors. These two aspects are risk and term of maturity.
Risk and Return
Corporate bonds provide the safety of most traditional debentures while at the same time compensating you for the extra risk incurred for investing in a private corporation. Of course the actual risk of a corporate bond depends greatly on the credit-worthiness and stability of the underlying corporation issuing the bond.
You don’t have to depend on your own research or that of your broker in evaluating most corporate bonds. There are two well-known companies that regularly issue corporate bond ratings. These companies are Moody’s and Standard & Poor’s. These companies have gained enough clout (Moody’s more so in bond’s) that the rating they give the creditworthiness of a corporation greatly affects its finances in the present term and long into the future.
Obviously the riskier the company is considered to be the greater the compensation to the investor in terms of return. It pays to actually think about why a company would be rated risky by either Moody’s or S&P (Standard & Poor’s). For example, if a company derives a great percent of its overall profit from one particular product, which might be affected by a lawsuit, then it behooves you to find out more about the particulars of this situation. These are the type of situations that can be capitalized on because most people will simply follow the consensus without actually researching the particulars. Of course this same rationale applies to other investments as well.
The basic concept important to investing in corporate bonds is that return increases directly proportional to perceived risk. Notice, the key is perceived risk. Information is the most important asset in the world of investments and those with the quickest and most accurate information usually profit the most.
Term of Maturity and Return
The term of corporate securities vary in the same way that other debentures. Most terms range from less than one year up to a maximum of thirty years. The rate of return increases directly proportional to the length of term. Therefore, the maximum return will be found in securities with longer maturities.
Other Considerations for Corporate Bonds
Call Features – Some corporate bonds will contain a call feature, which allows the corporation to retire or redeem the bond partially or in full within a certain time period. This is something that obviously affects the overall return of the bond and should be considered in the analysis. Any such features will be described in the indenture which is the legal document outlining the rights and restrictions of the lender and lendee.
Secured / Unsecured – Bonds can either be secured or unsecured. A secured bond is a bond that is attached to an asset of the corporation. Therefore in the event of a bankruptcy of default the asset could be liquidated to pay off the loan.
Information is for educational purposes only and is not be interpreted as financial advice. This does not represent a recommendation to buy, sell, or hold any security. Consult your financial advisor.