Sometimes companies need to borrow money, and one of the ways they raise the funds is by selling bonds. When you buy a corporate bond you are loaning money to a company.
Corporate bonds are the riskiest of the fixed-income
securities because only the individual corporation backs them and
companies are much more likely than governments to have serious
financial problems. Corporations reward you for taking the extra
risk by paying a higher interest rate than you would get on most
The interest rate you receive is called the coupon.
If you hold the bond until maturity, you'll receive the face value
of the bond -- assuming the company doesn't default. If you sell
the bond before maturity you risk losing principal if interest rates
Bond prices fall when interest rates rise and, conversely,
bond prices rise when interest rates fall. If you buy a 10-year
bond with a face value of $5,000 and a coupon, or interest rate,
of 6 percent and decide to sell it after three years when interest
rates have risen to 8 percent, no one would want to pay you the
full value of your bond because new bonds would be paying higher
interest. Of course, if rates have fallen by the time you decide
to cash your bond, you could get a premium for it since it's paying
more interest than new bonds.
Two debt-rating agencies, Standard
& Poor's and Moody's,
assign credit ratings to corporate bonds based on the company's
ability to repay its debts.
The poorer the rating, the higher the interest you'll
receive. That's because you're being paid to take on the added risk
that the company might default on its repayment of the bond. Even
the high and the mighty can stumble -- Ford Motor Company's bonds
were once close to junk status. Investors were paid handsomely for
their faith that Ford wouldn't default. But, generally, this is
a very tricky area to invest in. Most novice investors would fare
much better sticking with higher quality bonds.
You can buy corporate bonds through a broker or by
visiting the company's Web site where you'll often find contact
information for purchasing bonds. But usually the best way for individuals
to buy corporate bonds is through a bond fund.
Bond funds are an inexpensive way to get exposure
to a wide variety of companies, which helps reduce risk. The fund
is professionally managed and you can check with a fund rating company
such as Morningstar
to gauge the fund's performance.
As with all bond funds, the drawback is there's no
guaranteed return of principal as there is with individual bonds
that are held to maturity. While each bond within the fund has a
maturity date, the fund does not. You'll have to decide the appropriate
time to sell your shares.