Types Of Corporate Bonds : Which you need to know

There exist various different types of corporate bonds, but before understanding the types it is important to understand about corporate bonds. A corporate bond is a financial instrument which is issued by a company, private or public, with the purpose of raising funds for its own use such as expanding the business, to meet ongoing operational expenses, etc. Corporate bonds are used as a method of debt financing by companies. 

It is categorized as a debt instrument because an investor who opts for this investment is lending money to that particular company and in some cases in return for a series of interest payments. 

Investors can also select corporate bonds on the basis of their risk appetite as bonds are credit rated. The highest rating is AAA and the lowest or junk quality bonds are rated as C or D, higher the rating higher will be the safety of the financial instrument. 

Corporate bond tenures can range from anywhere between 1-30 years and these bonds usually offer a higher interest rate than government bonds due to the higher risk that they carry. However, before investing in this instrument it is advised that an investor should consult their financial advisor beforehand.

Benefits of Investing in a Corporate Bond

There are various advantages of investing in corporate bonds: 

1. Liquidity: a majority of corporate bonds trade in the secondary markets. This allows investors to continuously buy and sell without much issue thereby providing them liquidity. 
2. Multiple Options: there are various types of bonds available based on duration, risk and interest payments. 
3. Higher interest rates: as compared to government bonds, these bonds give higher interest rates due to the higher risk that they possess.
4. Low risk: as compared to equity instruments, bonds possess a lower risk level as compared to equity investments whose performance is directly linked to the markets. 
5. Safety: these bonds possess a rating that indicates their safety. The higher the rating the better the safety, AAA rated are the safest. 

Different Types of Corporate Bonds

Now that it has been understood what a corporate bond is, we can dive into the different types of corporate bonds. 

As per Structure

1. Senior Secured Bonds: These bonds as the name suggests take topmost priority over any of the other sources of capital in the company. Investors of these securities will be given priority in terms of being paid in the event of a default. 
2. Senior Unsecured Bonds: These bonds do not have any specific collateral set against them which will guarantee a portion to the investor. However despite these, investors of these bonds also hold a privileged position in the event of a default, under the payout order.
3. Junior, Subordinated Bonds: Bonds in this category are usually referred to as debentures and are paid out only after the senior securities are paid out. These bonds are also categorized as unsecured debt which means there is no collateral against them. These bonds only hold the issuer’s good name and the credit rating as some form of security. 
4. Guaranteed and Insured Bonds: These bonds as the name suggests are guaranteed in the event of a default by a third party. This indicates that in the event where the issuer is no longer able to make payouts the third party will continue to do so on behalf of the issuer.

As per Duration

1. Short- Term: These are those corporate bonds that hold a maturity of less than 3 years and have a lower risk level as compared to medium and long term bonds as they are less susceptible to interest rate risk. 
2. Medium- Term: The tenure of these types of bonds usually last between 4 to 10 years and these are more susceptible to interest rate risk as changes in the medium to long term can happen due to certain factors like the economic scenario, a particular event, etc. 
3. Long- Term: These types of bonds have a tenure which is more than 10 years and usually offer a higher yield as compared to the previous 2 categories due to the fact that the investors funds are being tied up for longer. 

As per Risk Level

1. Investment grade bonds: These are those kinds of bonds which are issued by those companies which are the least likely to default. 
2. High yield or Junk bonds: These are those kinds of bonds that offer some of the highest interest rates possible however it must be noted that these bonds have a credit rating of B or lower and possess extremely high levels of risk. These are considered speculative in nature. 

As per Interest Payment

1. Fixed Rate: These are also known as plain vanilla bonds. An investor will receive regular interest payments when investing in this type of bond. 
2. Floating Rate Bonds: These are those types of bonds in which the interest rate is revised at certain intervals, almost at intervals of 6 months. Thus the payments made under this scheme will change as per the prevailing rates.
3. Zero Coupon Bonds: These bonds do not make interest payments till the time of maturity. Taxes are borne by the investor on the accrued value of payments. 
4. Convertible Bonds: These bonds come with the option to convert them into predefined stocks, hence an investor has the flexibility to take exposure to shares if they feel that is the financial instrument that is more suitable for them. 
5. Non- convertible Bonds: As the name suggests these bonds do not have an option to be converted into shares if the investor wishes to. 

Frequently Asked Questions (FAQs):

1. What are the most common corporate bonds?

The most common bonds are fixed rate bonds. This is because they make regular interest payments and are suitable for an investor looking to earn some regular income out of their investments. 

2. What is the safest corporate bond?

Corporate bonds are credit rated and the safest ones are the one with AAA rating. 

3. How can an investor benefit from investing in Corporate Bonds?

The main benefit that investors can obtain is that this investment gives regular interest payments at regular intervals and once the tenure is completed the company will return the investor their principal amount also. 

4. Why would a company prefer to issue a bond rather than borrowing from the bank?

Due to the fact that the company has to pay interest on the investment, if the company feels they can raise money at better rates by issuing a bond then they will opt for that. 

5. What kind of interest can I expect from Bonds?

The interest rate varies from bond to bond depending on a multitude of factors such as the duration, the credit rating, the quality of the company, etc. An investor should check with their respective RM before investing.

6. What is the difference between a secured and unsecured bond?

Secured bonds/debt is that in which the borrowing entity puts up some asset as a form of security or collateral for the loan. Unsecured bonds/debt have no such backing in the form of collateral, the lenders invest funds based solely on the creditworthiness of the company or their belief that the company will be able to repay them without any issue.