Corporate bond
Rules, protection and tax below are for South Africa.
What it is
A loan to a company, packaged as a tradeable bond. Companies borrow this way to build factories, refinance old debt or buy other companies. In return they pay a fixed coupon, usually higher than a government pays, because a company can fail in a way a rich-country government does not.
The extra yield over government bonds is the market's price for that risk. Bonds from large, profitable companies pay a little extra; bonds from weak or heavily indebted companies, called high yield or junk, pay a lot extra and default far more often.
If a company fails, bondholders are paid before shareholders from whatever is left, which is why bonds are less risky than the same company's shares, not risk free.
How it works
- A company issues bonds with a coupon, a maturity and a place in the queue if things go wrong.
- Rating agencies grade the issuer; the grade and the market's mood set the yield you get.
- You receive coupons on schedule and the face value at maturity, unless the company defaults.
- Prices move with interest rates and with news about the company, so selling early can gain or lose.
The honest pros and cons
For
- Higher income than government bonds from the same currency.
- Bondholders rank ahead of shareholders if the company fails.
- A fund holding hundreds of issuers spreads the default risk thinly.
Against
- Companies default; high-yield bonds lose money in every recession.
- The extra income over government bonds is often smaller than the extra risk deserves.
- Single bonds are hard for retail investors to buy and sell at fair prices.
- In a crisis corporate bonds fall together with shares, just when you wanted them to hold.
Getting it in South Africa
not researchedWherever you are
- Decide whether you want investment grade or high yield; they behave like different asset classes.
- Use a fund unless you can hold twenty or more issuers directly; one default in a small holding is a large loss.
- Look at the yield spread over government bonds and ask whether it pays you enough for the default risk.
Go deeper
Also called
company bonds, debentures, obligaciones negociables, high-yield bonds, junk bonds
Often confused with
- Government bond: A loan to a government that pays interest and returns your money on a set date, called its maturity.
- Term deposit: Money locked at a bank for a fixed period in exchange for a known interest rate.
- Domestic shares: Part ownership of a company listed in your own country.