Corporate bonds give you the chance to loan your hard-earned money to giant corporations such as GM and GE. Companies use two means to raise money - they issue stock and they float bonds. When you buy stock, you're an owner of the company; when you buy bonds you are a lender to the company.
Corporate bonds of financially sound blue chip companies are considered very safe investments, and they pay slightly higher yields than government bonds. All bonds are rated by such investment services as Standard & Poor's or Moody's. Bonds rated BBB or higher (through AAA) by Standard & Poor's or Duff & Phelps, or Baa by Moody's are considered investment-grade bonds. Anything rated lower would be considered a "junk bond."
Most bonds pay interest semiannually. Depending on the financial creditworthiness of the issuing company, a corporate bond can yield from 1 to 3 percent points more than Treasuries of the same maturity.
Like all bonds, corporate bond prices are sensitive to general fluctuations in interest rates. They are also affected by the financial fortunes of the issuing companies. The price might rise if the company's finances improve because investors anticipate that the bond's safety rating might be upgraded. On the other hand, a company that experiences some financial problems could see its bond price decline because of investors fears that the rating will be downgraded.
Most corporate bonds are known as debentures because they are unsecured. The bonds are not backed by collateral, but simply by the company's general ability to repay them out of cash flow and profits.
Corporate bonds are also available in zero-coupon bonds. You would receive the entire principal and all the interest compounded. If you don't want to buy individual corporate bonds, there are dozens of mutual funds that specialize in corporate bonds.
Who should buy corporate bonds?
Investment-grade corporate bonds are appropriate for income-oriented and conservative investors who want a higher yield than would be available with government bonds. They also might be suitable for aggressive stock-oriented investors looking for diversification.
Aggressive investors looking for income might prefer corporate bonds over government bonds because of the superior interest rate, although there are a few other fixed-income investments that offer an even better return, such as junk bonds, real estate investment trusts, and convertible bonds, but they also provide some capital appreciation as part of the stock conversion value.
However, because corporate bonds pay full taxable interest, unless you need the income, it would be best to use corporate bonds in your tax deferred retirement account..
Who should not buy corporate bonds?
If you don't want income, corporate bonds are not for you. If you want income buy you want absolute safety, you might prefer government issues. But AAA-rated corporate bonds are considered very safe and offer better returns than government bonds.
Municipal bonds
Aggressive investors looking for the highest potential return might also steer away from corporate bonds. Although they pay a better yield than some fixed-income investments, they still short of junk bonds, real estate investment trusts, and some other types of income-oriented investments, and they fall far short of the average annual return offered by stocks. However, corporate bonds are considered much safer than stocks for buy-and-hold investors.
