What is a corporate bond?
A corporate bond is a form of debt security -- essentially an IOU -- issued by public and private companies to investors. The money raised may be used to pay for acquisitions, debt refinancing, capital improvements and more. Unlike stocks, bonds do not offer investors any stake in the company. Corporate bonds are essentially loans repaid at a set interest rate and on a set schedule.
If you want to improve on certificate of deposit returns without taking on significant risk, consider investing in a laddered portfolio of high-quality corporate bonds.
The world of corporate bonds can be a bit intimidating to smaller do-it-yourself investors. If you're not well-versed in areas such as primary issues, the secondary market, credit quality risk, and buying at par, discount or premium, you may be tempted to stick with more plain vanilla investment options.
But there is a way to buy corporate bonds that makes bond selection and purchase much easier. It also enables you to simply create a diversified ladder that employs a variety of criteria. It's called InterNotes.
Do-it-yourself corporate bonds
InterNotes are primary issue, investment-grade corporate bonds made available only to individual investors. Each bond sells at par, $1,000, which is the minimum investment, and they can be purchased in increments of $1,000. The bonds are issued weekly and are typically available for purchase for 5 business days. You can buy them through most brokerages.
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Unlike bonds on the open market, which often have far higher purchase minimums and yields that fluctuate constantly, you don't have to make a quick decision about whether to buy corporate bonds through InterNotes.
"Prior to InterNotes, it was very difficult for individual investors to buy individual corporate bonds," says Tom Ricketts, chairman of Chicago-based Incapital, the co-agent for InterNotes.
"This simplifies and slows down the whole process for individual investors. They can understand what they're buying and have time to make an informed decision because the issuers accommodate the individual investor by holding the rate firm from Monday through the following Monday."
A recent offering of investment grade bonds on InterNotes included a Discover Financial Services bond with a yield of 3.85% and a Prospect Capital Corporation bond yielding 5.5%.
Other companies offering securities through InterNotes include Goldman Sachs, Ford Motor Credit Co. and Deutsche Bank.
Spreading the risk
When laddering investment-grade bonds, you can diversify and spread your risk by buying bonds in different industries with differing maturities, yields and credit ratings. However, some corporate bonds are callable, meaning the issuer could decide to take back the bond and pay you off before the maturity date.
Investing in callable bonds therefore requires some caution because the best-laid plans can be derailed if a bond is called.
For example, if you buy a bond with a 5% yield and a year from now similar bonds are yielding 4%, the issuer may decide to call your bond so it can reissue the bond on the secondary market at 4%, reducing your earnings and requiring a new investment or laddering strategy. In a rising rate environment, bonds are less likely to be called because the issuer would have to pay a higher yield.
Ricketts says about 50% of InterNotes bonds are callable.