Bonds are an attractive form of borrowing for companies as well as one of the safest asset classes for investors. When a medium or large company needs to raise capital in the form of debt, they can choose from several options in order to do so, such as taking out a loan from a bank or issuing a bond.
Bonds are suitable means of funding for several reasons. Through a bond issuance, a company can build up liquidity for potential acquisitions and growth opportunities that may arise. They can also refinance maturing existing debt or take out any existing undesired corporate obligations. Moreover, bond issuers can also finance imminent capex (Capital Expenditures) or other financial commitments.
The investors who purchase a corporate bond, are lending that amount of money to the corporation with the promise that the capital will be paid back at the maturity while receiving coupon payments in the meantime. The process is similar for every bond, but there are many different kinds of corporate bonds, each with their own contingencies. Apart from corporate bonds, bonds is a common way of financing also for Governments and Municipalities. Government and Municipal bonds which have their own characteristics and specialized investor base.
Most bonds issued, are given a rating by a credit agency such as Standard & Poor’s, Moody’s, and Fitch. These agencies rate the bond by its quality and the likelihood that the company will meet its financial requirements of the bond. The main characteristic of investment grade bonds is the relatively low risk of default. All types of bonds are subject to upgrading or downgrading from these agencies. Only companies that keep their financial and credit performance above a certain level as defined by the rating standards of the agencies can maintain their investment grade status.
These bonds often pique the interest of investors because they offer a high-interest rate upon their issue. High yield bonds are issued by companies that their financial and credit performance is below that of an investment grade. Since high yield bonds come with a high risk, the company issuing it compensates their investors with a large return. Investors in high yield bonds are well-versed with the risk and return profile of such bonds and invest in them in order to attain higher returns than investment grade bonds.
A zero-coupon bond is one that has been purchased by the investor at a deeply discounted price but will be paid the full amount of the bond at maturity. Zero Coupon bonds don’t pay interest in the form of coupon thus the name zero-coupon. The price of these types of bonds is more volatile than that of the more standard bonds as the entire payment takes place at maturity.
Callable bonds are called callable as the issuer of the bonds, can repay the capital and stop interest payments after a predefined time (according to the schedule of callable dates) before maturity. Usually callable bonds can be corporate or municipal bonds. Investors in callable bonds receive higher coupon than they would receive from a noncallable bond but they should avoid this type of bonds if they want predictable income and return on their investment. A company can issue a callable bond in order to take advantage of a potential interest rate drop in the future. That means that if the interest rates indeed decrease then the company can redeem the amount outstanding and make a new debt issue at a lower rate.
A Convertible bond is a debt obligation of a corporation and can be exchanged for a set number of common shares of the issuing corporation at a predefined conversion price. It is usually considered to be a flexible funding option for companies as it provides investors with several incentives and at the same time, it assists companies to overcome certain barriers when raising capital and lower their borrowing costs.
These bonds are bonds in which the investor receives interest with no maturity date to which the bond will need to be paid in full by the company. Perpetual bond payments are similar to stock dividend payments, as they both offer a fixed-income type of return for an indefinite period of type.
From the investor’s point of view, it’s important to remember that a truly diversified portfolio relies on various types of investments in order to remain balanced. Bonds can make a great addition to a portfolio because they represent a fixed income cash flow to the investor and are usually less risky than stocks.
From the company’s point of view, corporate bonds have the potential to grow companies, expand services, and increase capital across all sectors and geographies.
In addition to the main types of bonds, it is also important to understand the existence of different security types of corporate bonds like senior secured bonds, senior unsecured bonds, subordinated corporate bonds and guaranteed and insured bonds.
The main distinction between these types is whether the bond is backed by a collateral and which type of holder is first to receive a payment from the liquidation of a company’s assets in the case of a default.
Corporate Bonds can have many different types while they can also be a flexible funding mechanism that can serve a big range of corporate entities in order to materialize their growth and expansionary plans and cover their existing and future financial needs. Fixed Income Experts can conduct a proper assessment of the particular business case so that the company can issue the most suitable type of bond and according to its capabilities and its historical credit performance.