A bond is a way for a business to make money by issuing a debt security that is sold to investors. The bonds are essentially an IOU with the promise that the company will pay back the loan with interest after a period of time. A crash course on corporate bonds may be the perfect thing you need to understand how some businesses make money.
What are Corporate Bonds?
Corporate bonds are considered to have a higher risk than government bonds, but many investors choose corporate bonds because of the higher interest rate. This means that an investor will get more money in return when compared to a government bond. For example, current government bonds are around 1-2%, and corporate investments are 3-7%.
How Do Corporate Bonds Work?
Rather than borrowing from a bank, a company borrows from investors by issuing a bond that can be traded on the stock market. The bond is an IOU that promises the investor a return and a profit from interest represented as a percentage. The interest rate can vary based on how much money the company needs. Periodically, payments will be made to the investor until the loan is completely paid off with the promised interest.
Because interest rates change and can plummet, some corporate bonds have a call provision. This allows early repayment if the interest rates change. Investors can also choose to sell the bonds before they mature.
What are Municipal Bonds?
Unlike corporate, municipal bonds are issued by the state, municipality, or county. These bonds are used to finance capital expenditures like highway construction, bridges, or schools. Municipal bonds are exempt from federal taxes and some state and local taxes. Municipal bonds are particularly attractive to people who are in the high-income tax brackets because of the tax exemptions.
There are two types of municipal bonds including general obligation bonds and revenue bonds. A general obligation bond (GO Bond) is issued by the government and is not backed by revenue from a project. Some general obligation municipal bonds are backed by dedicated property taxes while others are payable from general funds.
A revenue bond is a municipal bond supported by the revenue from a particular project, like a toll bridge. Typically, they are issued by a government agency or fund that is managed in the manner of a business to have both operating revenues and expenses.
Are Corporate Bonds Like Stocks?
The corporate bond market is different from the stock exchange. When purchasing bonds, investors are lending money to companies. Alternatively, when an investor purchases stock, they are buying a piece of the company.
The value of the stock rises and falls with the market, but the corporate bond market will only earn interest rather than profits. If a company goes bankrupt, the bondholders and creditors are paid before stockholders. This can make bonds a more secure financial strategy when compared to stocks because a bondholder is more likely to receive payment even if the company goes under.
