Debt Instruments – What are Corporate Bonds?
What are Corporate Bonds?
Corporate Bonds are issued for minimum amounts of USD100 million and sometimes for billions of dollars. Maturities are generally 5 to 10 years but in most markets can be for 25 years or longer.
Coupons are almost always fixed for the period, but can be structured as deep discount, zero coupon or index-linked. It is possible to issue floating rate notes (most issues by banks are FRN’s) but these are more usually issued by corporates under an MTN programme. The common currencies are USD, Euro and sterling.
The most liquid market is in investment grade bonds i.e. those rated BBB-/Baa3 or higher, but there is an established high yield market in the US and a growing one in Europe, for bonds with a speculative grade rating of BB+/Ba1 or lower (also known as ‘junk bonds’). Bonds can be registered (like shares) or bearer instruments.
How do Corporate Bonds reflect in financial statements?
Corporate bonds are reflected in financial statements as either an asset or a liability, depending on the issuer’s perspective.
For the issuer of the bonds, the bonds are a liability that represents debt that must be repaid to bondholders. The bonds are recorded as a liability on the issuer’s balance sheet and the interest payments on the bonds are recorded as expenses on the income statement.
For the holder of the bonds, the bonds are an asset that represents a claim to future cash flows in the form of interest payments and the repayment of the bond’s face value. The bonds are recorded as an asset on the holder’s balance sheet and the interest received from the bonds is recorded as income on the holder’s income statement.
Benefits of Corporate Bonds
- Income: Corporate bonds offer a regular stream of income in the form of coupon payments.
- Predictable cash flows: Corporate bonds have a set maturity date and fixed coupon payment, making the cash flows predictable for investors.
- Diversification: Adding corporate bonds to an investment portfolio can help diversify a portfolio and reduce overall portfolio risk.
- Potential for Capital Appreciation: Corporate bonds can potentially increase in value if market interest rates fall, and can be sold for a higher price than their original purchase price.
Risks of Corporate Bonds
- Credit risk: The risk that the issuer of a bond will default on its interest or principal payments.
- Interest rate risk: The risk that changes in interest rates will negatively impact the market value of the bond.
- Market risk: The risk that the value of a bond will fluctuate due to changes in market conditions.
- Liquidity risk: The risk that it may be difficult to sell the bond before its maturity date, especially in times of market stress.