Corporate Bonds BasicsBond Instruments
Corporations issue bonds in order to borrow financial capital. Issuing corporate bonds and repaying the debt over long periods of time can be more appropriate for firms who don’t want to lose equity. Instead of reducing shareholder equity percentages, they simply sell bonds and use this funding to expand. The firm also gets the privilege of customizing the bonds to their needs, as long as they can sell.
Why should you choose corporate bonds if you have access to treasuries? Corporate bonds, even those rated as safe an investment as government bonds, offer significantly higher rates of return. By purchasing corporate bonds, you exchange your almost perfect immunity to default for a higher return. Corporations are more likely to default than governments, although investment grades rarely actually default. While governments can print more currency to supply their bond purchasers, corporations cannot. The highest rated investment grades have a low possibility of defaulting.
As an investor, you primarily care if the firm can pay back its debt. Remember that you are essentially loaning this company money. You don’t particularly care if the firm has a high growth rate, as long as they repay at maturity. You are focusing on sustainability, not growth. In a sense, Bonds are playing defensively. You will still analyze the issuers of your potential bond investments, but you should focus and orient your selections differently. The due diligence should focus on identifying the worst case scenarios and the chances of default before maturity.
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