What Are Corporate Bonds?
Corporate bonds are debt securities issued by corporations to raise capital for various business purposes, such as financing growth initiatives, funding acquisitions, refinancing debt, or covering operational expenses. When investors purchase corporate bonds, they are effectively lending money to the issuing company. In return, the company legally commits to paying interest—known as coupon payments—at predetermined intervals and returning the principal amount (face value or par value) upon maturity. Unlike owning stock, bondholders do not gain equity or voting rights in the company; their return is limited to interest income and principal repayment, regardless of the company’s profitability or stock performance. However, in the event of financial distress or bankruptcy, bondholders have priority over shareholders to claim the company’s assets.

Types of Corporate Bonds and Their Characteristics
Corporate bonds can be broadly categorized into secured and unsecured debt.

Secured debt is backed by specific collateral. This includes:
- Mortgage bonds, which are secured by the company’s real estate and physical assets. These bonds function similarly to a home mortgage, where the pledged assets generally exceed the loan amount, offering a cushion to bondholders. If the issuer defaults, bondholders may foreclose and sell the collateral to satisfy the debt, although a shortfall may still leave them as general creditors.
- Equipment trust certificates are common in industries such as railroads and airlines, where rolling stock or aircraft are financed directly through bonds secured by the equipment itself. These certificates operate similarly to auto loans, with the equipment serving as collateral that the lender can repossess upon default.
- Collateral trust bonds are backed by marketable securities held in trust, which may include stocks or bonds owned by the issuer or others. The quality of these bonds depends on the value and liquidity of the securities pledged.
Unsecured debt, often called debentures, lack specific collateral and depend solely on the issuer’s creditworthiness and earnings capacity. Some debentures are further classified as subordinated, meaning they rank behind other debt obligations in claims priority but still precede equity claims. Another variant is guaranteed bonds, where a third party—often a financially stronger corporation—guarantees payment of interest and/or principal.

Credit Ratings and Investment Grade
Credit rating agencies such as Standard & Poor’s, Moody’s, and Fitch assess the credit quality of corporate bonds, assigning ratings that reflect the likelihood of timely payment. These ratings range from high-grade investment bonds (e.g., AAA) to lower-rated speculative or "junk" bonds, which offer higher yields to compensate for increased default risk. Credit ratings are crucial for investors, as they influence both the interest rate the issuer must offer and the bond’s marketability.

Bond Terms and Pricing
Corporate bonds are typically issued in $1,000 increments and pay interest semi-annually, although some may pay monthly, quarterly, or annually. Bonds may have fixed coupon rates, paying the same interest amount regardless of market fluctuations, or floating rates, which reset periodically based on a benchmark rate plus a spread. Another type, zero-coupon bonds, pay no periodic interest but are issued at a discount and redeemable at face value at maturity, with the difference representing the accrued interest.

The market price of a bond fluctuates inversely with prevailing interest rates. When interest rates rise, existing bonds with lower coupon rates become less attractive and trade at a discount; when rates fall, these bonds trade at a premium. Yield to maturity (YTM) is a key metric that expresses the total expected return if the bond is held to maturity, accounting for the purchase price, coupon payments, and principal repayment.

For example, a bond with a 4% coupon rate and a $1,000 face value priced at $900 will have a higher yield to maturity than 4%, compensating for the lower purchase price. Conversely, a bond priced above par will have a lower YTM than its coupon rate.

Risks Associated with Corporate Bonds
Investors in corporate bonds face several risks, including:

Credit (default) risk: The possibility that the issuer may fail to make timely interest or principal payments. Bond indentures often contain covenants—contractual promises by the issuer to maintain certain financial ratios or limit additional borrowing—to protect bondholders. Bond trustees oversee compliance and can take action if covenants are breached.
Interest rate risk: Bond prices fall when market interest rates rise. Longer maturities and lower coupon rates generally increase sensitivity to interest rate changes. Hence, bonds with longer durations or low coupons are riskier in rising rate environments.
Inflation risk: Inflation erodes the purchasing power of fixed interest payments and principal, reducing real returns over time.
Liquidity risk: Corporate bonds may trade less frequently than stocks, making it difficult to sell without affecting price, especially for bonds issued by smaller companies or with lower credit ratings.
Call risk: Many corporate bonds include call provisions allowing issuers to redeem bonds before maturity, often when interest rates decline. This can disadvantage bondholders who must reinvest proceeds at lower yields.

Portfolio Role and Investment Considerations
Corporate bonds are commonly included in diversified portfolios to balance risk and return, often offsetting the volatility of equities. Investors vary their bond holdings across maturities, credit qualities, and sectors to manage risks and optimize income. Some choose to invest directly in individual bonds, while others prefer bond mutual funds or ETFs, which provide diversification and professional management.

Unlike bank deposits, corporate bonds are not insured by the FDIC, making issuer creditworthiness and bond ratings important factors in investment decisions.

Research and Monitoring
Investors should review bond prospectuses, which disclose terms, risks, issuer financials, and intended use of proceeds. Public companies issuing bonds file periodic reports (e.g., 10-K and 10-Q forms) that provide ongoing financial information. Mutual funds and ETFs focused on bonds also publish regular reports detailing holdings and performance, accessible through SEC filings or fund websites.